Here’s a small cap stock flying mostly under the radar but worth examining because it has a history of predictable earnings, a rating of undervalued, and a dividend of 3.90%.
Computer Programs and Systems, Inc. (CPSI, Financial) provides medical information technology (IT) systems to small and mid-sized rural and community hospitals. It’s making the most of pressure on hospitals to increase patient care and productivity metrics, as well as the need among hospitals for efficient billing and reporting.
It came to our attention through the Buffett Munger screener at GuruFocus. Getting through the screener requires that a company have solid earnings growth over the previous five years, and that its price rank as fair or under valued.
The following chart gives us the essentials (green line for price, blue line for revenue, and red for earnings) at a glance:
History
1979: the company is founded
1981: first acute care hospital installation
2002: goes public on NASDAQ
2008: CPSI places 97th on Forbes magazine’s America's 200 Best Small Companies (the first of multiple times on the list)
2013: forms TruBridge, LLC, a wholly owned subsidiary of CPSI; it offers business, consulting and managed IT services to non-hospital facilities (such as clinics)
2014: places 50th on the Forbes list (now called, America’s Best Under a Billion) History section based on information from the company website and Forbes magazine.
CPSI’s business
Overview: provides healthcare information technology solutions for rural and community hospitals.
More specifically, it offers what it calls "comprehensive" software and hardware products, along with installation services and support. Its enterprise-wide systems automate clinical and financial data management in each of the functional areas of a hospital.
Hospitals with 300 or fewer acute care beds are the target market, and it focuses on hospitals with 100 or fewer acute care beds; such hospitals make up 94% of its customer base. It has more than 650 client hospitals in 46 states and the District of Columbia.
In 2013 it formed a wholly owned subsidiary, TruBridge, LLC, which provides similar IT services and consulting to non-hospital facilities, including doctors’ offices, as well as business management consulting.
Incorporated in Delaware, Computer Programs and Services, Inc. is headquartered Mobile, Alabama, and has more than 1,400 employees.
Revenue sources
The company generated just over $200 million in revenue in 2013. As this excerpt from its 10-K Report shows, it has three main revenue sources:
The company notes that many of its client hospitals depend on Medicare and Medicaid populations.
Competition
The company lists, in its 10-K for 2013, the following companies as its main competitors: Medical Information Technology, Inc. (private), Healthland Inc. (private) and Healthcare Management Systems, Inc. (private). These companies compete directly in CPSI’s target market of small and midsize hospitals.
It also faces occasional competition from what it calls secondary competitors, which include McKesson Corporation (MCK, Financial), Quadramed Corp. (private), Cerner Corporation (CERN, Financial), Quality Systems, Inc. (QSII, Financial), and Siemens Corporation (trades on German and other European stock exchanges). Normally, these competitors focus on larger hospitals but sometimes do go into the small and mid-size hospitals market.
CPSI must compete with specialists such as providers of practice management systems, general decision support and database systems, and other segment-specific applications, as well as from healthcare technology consultants.
It believes hospitals consider the following competitive factors when making buying decisions:
- product features, functionality and performance;
- level of customer service and satisfaction;
- ease of integration and speed of implementation;
- product price;
- knowledge of the healthcare industry;
- sales and marketing efforts; and
- company reputation.
Takeaways: Computer Programs and Systems, Inc. Is a technology company that provides IT service to small hospitals, most of them with fewer than 100 beds (rural and community). Those client hospitals number more than 650, and are spread across 46 states. Revenue comes in three main streams: (1) system sales, (2) support & maintenance, and (3) business management, consulting, and managed IT services. It faces competition, but indications are that the competition is not intense.
Growth
Historically, CPSI has posted strong top and bottom line numbers:
Looking forward, the company sees continuing growth, through three broad areas:
- Expanding sales of healthcare IT systems and related services to existing and new customers. In this area, it enjoys support of the federal government through the American Recovery and Reinvestment Act, which has more than $19 billion for healthcare organizations that modernize by acquiring and using information technology.
- Sales of new and additional products to the existing customer base; this is expected to get additional momentum from ongoing growth of the customer base, and from new products it develops internally.
- Third, it projects future growth through TruBridge, the wholly owned subsidiary created to provide business management, consulting and managed IT services. This would again allow it to build, in this case with services, through its existing markets, and by expanding into rural and community hospitals currently served by other IT product providers.
Takeaways: As the chart above shows, management has successfully grown the company’s revenues and earnings in the past. We have no reason to believe it will not be able to continue that growth with its three-pronged plan for the near and longer-term future.
Management
President and Chief Executive Officer: J. Boyd Douglas, age 47 (at the time of publication of the 2013 10-K), has served in these positions since 2006 and as a director since 2002. He began his career with CPSI in 1988 as a financial software support representative.
Chairman of the Board, Chief Financial Officer and Director: David A. Dye, age 44 (at the time of publication of the 2013 10-K), has served as chairman since 2006 and as a director since 2002; served as president and chief executive officer from 1999 to 2006; began his career with CPSI in 1990 as a financial software support representative.
Board of Directors: Six members, including Chairman Dye and CEO Douglas. Areas of experience and expertise include banking, energy distribution, healthcare, aerospace, law, food manufacturing, and IT.
Managment and Board information based on the company’s 10-K Report for 2013 and BusinessWeek.
Takeaways: A seasoned senior executive team, and yet young enough that succession planning should not be an issue; the board has a reasonable range of connections.
Ownership
Gurus: Among the gurus followed by GuruFocus, the following four have holdings in CPSI: Paul Tudor Jones (Trades, Portfolio), Chuck Royce (Trades, Portfolio), Jim Simons (Trades, Portfolio), and Joel Greenblatt (Trades, Portfolio). Jim Simons (Trades, Portfolio) has the biggest position, at 160,021 shares.
Institutional Investors: According to nasdaq.com, almost 90% of outstanding shares belong to institutional investors:
Short interests: GuruFocus puts the short interest in Computer Programs and Systems at 11.2%, which is roughly mid-range for this company:
Insiders: This group holds 11% of the company’s shares, according to GuruFocus. Yahoo! Finance reports the two biggest insiders are Senior Vice President Michael Muscat with 343,793 shares and CEO Douglas with 159,845 shares.
Takeaways: As we might expect from a company with strong earnings growth, there is a high level of institutional ownership. And given that the number of shares held by institutionals and shorts totals more than 100%, it’s likely some institutional shares have been loaned out to shorts. Insider interest is strong.
By the Numbers
Takeaways: The current stock price is nearing its 52-week low, pulling its P/E down into the high teens, and giving it a dividend yield of 3.90%; it also boasts a notably high ROE at 50.55%.
Financial strength
CPSI posts excellent numbers –Â 9/10 for Financial Strength and 9/10 for Profitability & Growth –Â in the GuruFocus system:
These screens show at a glance there are no significant concerns about the financial health of this stock. One semi-red icon suggests that Return on Capital (Joel Greenblatt) is not as strong as it has been, historically (Return on Capital measures EBIT divided by the total of net fixed assets and net working capital).
One of the reasons for this strong showing is the absence of long-term debt. Looking at the historic financials for Computer Programs and Systems we see the company has been debt-free since appearing as a public company in 2003.
We also note from the financials that the company has not issued shares in lieu of debt. Over the past 10 years the number of shares outstanding has gone from 10.5 million to 11.2 million.
The other is the strong free cash flow generated:
While we see some ups and downs, particularly in the wake of the financial crisis, overall there has been a strong upward trend.
Takeaways: With zero long-term debt, no big share issuances, and strong free cash flow, CPSI should have no difficulty in financing the growth it plans in coming years.
Valuation
When Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) go looking for companies, one of their top criteria is consistent growth of revenue and earnings. While any company can have a good quarter or year from time to time, it takes a strong management team to generate consistently strong earnings over and over.
Computer Programs and Systems scores 4.5-Stars (out of 5) on the GuruFocus predictability system. That means it’s been a top performer for at least five years. Backtesting by GuruFocus has found that the higher the rating, the more likely the stock price will grow and the less likely it will suffer a loss. It cannot predict the future, of course, but past performance is the best guide we have to future performance.
Buffett and Munger also like to buy stocks that are not overpriced. GuruFocus uses P/E divided by 5-year EBITDA growth to classify valuations –Â a ratio known as PEPG or PEG. For example, if a company has a P/E of 20 and EBITDA growth of 10%, then it would have a PEG or PEPG of 2.0 (20/10); if the P/E is 15 and the growth rate is 20, then the PEG would be 0.75 (15/20). If the PEG is below 1.0, it is considered undervalued; if between 1.0 and 2.0 it is classified as fair valued, and anything above 2.0 comes in as overvalued.
As of the close of trading on December 3, 2014, CPSI had a P/E of 18.40 and grew its EBITDA at an average of 20.70% per year over the past five years. Dividing the former by the latter, we get a PEG of 0.89. Based on the criteria above, CPSI is considered undervalued. We can get a sense of this by looking to the right side of the following chart (green line for price, blue line for EBITDA):
Will the EBITDA line continue its upward trajectory? Using earnings as a proxy for EBITDA (we have no analyst estimates for EBITDA), it looks like the answer is yes, at least for 2014. The average estimate of earnings by analysts followed by Yahoo! Finance is $3.25 per share, up 10.2% from the $2.95 for 2013. For 2015, they predict $3.37, up again but by a smaller measure.
Takeaways: Computer Programs and Systems enjoys both a high predictability rating and an undervalued classification, making it worth the consideration of investors seeking to emulate the gurus at Berkshire Hathaway (BRK-B).
Opportunities and risks
Healthcare represents the biggest single piece of the American economy, $2.9 trillion and 17.4% of GDP in 2013. The Centers for Medicare and Medicaid Services ("CMS") predict that will increase to $5 trillion by fiscal 2022. And, hospital services account for the biggest part of that spending.
CPSI currently has 650 client hospitals; it’s now eyeing the other, roughly, 2,000 hospitals of that size, plus another 1,600 in the under-300 beds category, and small hospitals that specialize in areas such as surgery and rehabilitation.
A couple of important factors account for the growth of hospitals and CPSI’s optimism about its prospects:
Hospitals face increasing pressure to improve the quality of their care and their productivity, CPSI’s medical information systems can help them achieve gains.
As the baby boomer generation (the biggest bulge in age demographics) continues to age, the demand for health services will go up. But many will get that care through Medicare and Medicaid, so hospitals will need to do extensive reporting to the federal and state governments.
As noted, the American Recovery and Reinvestment Act has extensive funding for acquiring and using information technology.
Hospitals need information technology for clinical decision support systems, to reduce errors and improve patient safety, as well as cope with the shift toward value-based reimbursement.
Risks
The industry is, as the company notes, "...subject to changing political, economic and regulatory influences...", which is to say there’s a lot of uncertainty as governments change, as regulations change, and the economy unpredictably changes.
Hospitals, and especially rural and community hospitals, will get material amounts of their payments through Medicaid and Medicare, which in turn depend on the moods of the federal and state governments.
Failure, by the company, to comply with all current regulations could lead to financial penalties and loss of reputation.
Consolidation in the healthcare industry could reduce the size of the target market, and even cause the loss of client hospitals.
Opportunities and risks based on information in the Computer Programs and Systems 10-K Report for 2013 and historical data from the Centers for Medicare and Medicaid Services.
Outlook
Barring a black swan event, it seems likely CPSI will continue to build revenue and earnings as it has it in the past. While risks exist, they are, so far, theoretical rather than existing millstones holding the company down.
Conclusion
Computer Programs and Systems, Inc. meets two main criteria for being a Buffett Munger stock. It has predictable earnings, with a 4.5-Star rating in the GuruFocus system. In addition, at current prices it’s rated as undervalued.
It also pays a healthy and safe dividend of 3.9%, making it one of the few stocks that include both income and growth in a value package.
