Quantifying Quality Systems (QSII)

 

 

Quality Systems Inc. (QSII) was this month’s Online Stock study at the Better Investing website.  QSII makes health care information systems that automate numerous functions including billing and insurance claims, electronic medical and dental records, drug formularies, and appointment scheduling.  It sells primarily to doctors and dentists in group practices, to health centers, and to medical and dental schools.

 

Ken Kavala, who led the Online study, is a BI guru volunteer who specializes in small company stocks.  He writes a periodic column for Better Investing magazine on small stocks and also led the September 2008 Online study on Neogen, another small company stock that I discussed in a previous post, see:  Knowing Neogen, 9-8-2008 

 

Ken decided to lead this study much differently: participants got to vote for each judgment as usual but, unlike all previous Online studies, Ken got to make all of the final decisions.  Why you ask, why ask participants to vote if you are not going to follow their consensus?  Good Questions!

 

Materials available for downloading are the recorded session, Ken’s presentation slides, Ken’s SSG, and the Value Line report.

 

QSII consists of two divisions, QSI and NextGen.  QSI targets dental practices and contributed 8% of last year’s revenue while NextGen, a wholly owned subsidiary, specializes in medical practices and contributed 92% of last years revenue.  QSII currently ranks #4 on Forbes’ list of the 200 Best Small Companies, was #5 last year, and has been on the list for eight consecutive years. 

 

Better Investing defines small companies differently than Forbes.  BI uses Revenues or Sales, not capitalization, and Ken considered less than $500 M in Sales as Small.  Other gurus use $400 M as a cut-off.  With $186.5 M is Sales last year, QSII meets either definition. 

 

Here’s a chart comparing Ken’s SSG with three others and with Take Stock (a/k/a Quantifying QSII).  My assessment and conclusions follow.

 

 

Quality Systems (QSII)	Ken K from BI’s Online Study	Jim C from BI’s First Cut	Armin -1	Armin -2	Take Stock
Date	2-4-09	11-23-08	12-24-08	2-6-09	2-4-09
Data	S&P	same	same	same	Hemscott
Price	$37.10	$31.13	$44.31	$37.17	$37.11
52 week High & Low Price	$47.94 & $25.70	same & $26.90	same & $25.70	same & same	n/a
Project Growth From	Last Annual	Last Quarter	Last Quarter	same	Last Annual
Sales Growth	17.00%	18.00%	15.00%	same	18.60%
EPS Growth	16.99%	18.00%	15.00%	same	18.60% initial 16.10% final
High PE	30.0	28.0	30.0	28.4 (Alt-M)	28.0
High EPS	$3.09	$3.23	$3.12	$3.30	$3.05
High Price	$92.70	$90.40	$93.60	$93.70	$85.40
Value Line Estimated High Price = NONE
Low PE	15.0	17.0	14.6	12.0 (Alt-M)	19.7
Low EPS	$1.64 (TTM)	$1.55 (TTM)	$1.55 (TTM)	$1.64 (TTM)	$1.57 (TTM)
Low Price	$21.15 (low PE x low EPS)	$26.10 (recent severe low)	$22.60 (low PE x low EPS)	$19.70 (same)	$32.30 (low PE x low EPS)
Upside/Down	3.48	11.7	2.3	3.2	10.04
Total Return	22.59%	27.40%	19.60%	23.90%	20.10%
SSG Buy Under	n/a	n/a	$40.35	$38.20	$45.55
RV/PRV	n/a	74.4/63.0   (3 years  outliers)	104.0/ 90.4 (1 year outlier)	82.5/71.7   (same)	n/a
RV/PRV (no outs)	n/a	n/a	95.7/83.1	75.9/65.9	n/a
Quality	n/a	n/a	S&P = B 5 out of 8	same	TS = 10 top rating
PTPM – 5 yr ave	30.46% trend n/a	30.5% trend up	same	same	30.5% trend n/a
ROE – 5 yr ave End Equity	28.69% trend n/a	31.7% trend up	28.7% trend up	same	n/a
ROE – 5 yr ave Start Equity	n/a	n/a	33.6% trend up	same	33.8% trend n/a
Debt to Equity – 5 yr ave	n/a	n/a	-0- trend even	same	n/a

 

 

DISCUSSION:

 

This Online study used Better Investing’s Online SSG to analyze QSII while some prior studies used SSG software.   My SSGs and JimC’s used the Toolkit 5 software.

 

The Online SSG is much more limited than SSG software.  For example, the Online SSG is limited to projecting future growth only from the end of the last annual data point while the software offers three choices.  And, the Online SSG is limited to only one method for estimating the Forecast Low Price in the next 5 years while the software offers four methods.

 

(A) KenK’s SSG

 

 

– One of the first things Ken did was to replace the peers automatically selected by the Online SSG with three competitors: CERN, ELIP and MCK.  Peers and not the same as competitors and savvy users can replace them if they know where to find competitors.  Two web sites I use are Hoovers.com and YahooFinance, both of which show that the direct or top competitors of QSII are somewhat different than Ken’s picks: CERN, AMCS and GE Healthcare (pvt).

 

– Ken then compared QSII to the three competitors he chose and found that it was better in terms of Sales and EPS growth, Pre-Tax Profit, and Return on Equity

This slideshow could not be started. Try refreshing the page or viewing it in another browser.

.  He also compared QSII to S&P industry averages and found that it was better than its Systems Software industry average in terms of these same four variables .  Another plus was that QSII had no debt.  Ken concluded that QSII was a quality growth company.

 

– To decide QSII’s future Sales growth, Ken offered the participants five choices: 22.5%, the company’s 10 year historical average; 28.4%, the 5 year historical average; 18.7%, the most recent year’s actual growth from 2006 to 2007; 18.0%, S&P’s estimate for the next FY; and an open-ended “other.” The Consensus chose 18.0%, S&P’s estimate for next year.  Ken chose 17.0%, saying he wanted to be more conservative, but did not explain why he chose only 1.0% less than the Consensus.

 

** The average Sales growth for the last 10 years seems like a poor offering since changes are obvious just from the more recent choices that Ken offered.  And, my S&P Stock Report dated 2-2-09 estimates next year Sales growth at 15.0%, not 18.0% as Ken reported.

 

– To decide QSII’s future EPS growth, the group chose 18.0%, the same as its Sales growth choice, while Ken used 17.0%, the same as his Sales growth choice.  The other options that Ken offered were: 20.0%, the S&P estimate for the next 5 years; 16.5%, the most recent year’s actual growth; 19.0%, S&P’s estimate for the next FY; and “other.”

 

– Ken provided five choices to decide the Forecast High PE in the next years: 40.5, the 5 year historical average High PE; 45.0, the 10 year average; 34.9, the last 2 year average; 32.2, the most recent year High PE; and “other.”  The Consensus (50% of those who voted on this issue) chose “other” which I find baffling since it is meaningless without a numerical preference.  Ken used 30.0 which is also baffling since it was not one of the choices offered to participants.

 

– The last judgment was the Forecast Low PE and Ken offered five choices: 19.2, the 5 year historical average Low PE; the 10 year average; the last 2 year average; 18.5, the most recent year Low PE; and “other.”  Strangely, the Consensus again chose “other” which suggests they were unhappy with these picks.  Ken used 15.0, again another judgment call that was not offered to participants.

 

– Ken’s Forecast PE was 22.5 (High PE + Low PE / 2, or 30.0 + 15.0 / 2) and he pointed out that it compared favorably with Value Line’s estimated PEs for QSII .  I think this comparison provided an important benchmark and was especially useful since VL made no High Price estimate which is the yardstick I rely on most of the time.

 

** I use comparisons all the time to determine what’s reasonable and what’s not; if you’re interested, see: Determining What’s Reasonable and What’s Not, 7-14-2008

 

– A new feature with the Online SSG allows users to estimate the future Dividend Payout.  Ken changed the default 5-year average of 94.76% to 75.00% because QSII had paid special dividends in 2004 and 2005 that skewed the average to the high side.  His choice resulted in a 2.50% Yield which compared favorably with VL’s average dividend yield for the past three years [slides 49-52]. 

– The recent Repair Shop column in the March 2009 Better Investing magazine expressed some concern about the high level of QSII’s accounts receivable.  With receivables at 89 days worth of sales, it said that investors should watch for signs of problems.  The 11-14-08 VL shows that the company’s accounts receivable were $83.4 M in 2008, up from $76.6 M in 2007.

 (B) Armin’s SSG

– When I did my initial SSG, the six analysts I always check were estimating long-term EPS at an average of 20.20% with Zacks low at 18.40% and VL high at 23.30%; First Call via Yahoo Finance was 18.43%, S&P and FactSet CallStreet via CNN Money were 20.00%, and Reuters via Morningstar was 21.00%;

 

** FactSet’s estimate was from 5 analysts who ranged from 15.0% low to 25.0% high and my EPS growth rate was based on the 15.0% low estimate.

 

– When I updated my SSG on 2-6-09, those six analysts were estimating long-term EPS slightly less at an average 19.80% (down from 20.20%) with Zacks unchanged and still low, and Value Line unchanged and still high.  Reuters at 18.67% was the only estimate of the six that changed (down from 21.00%).

 

** Reuters.com has resumed making long-term EPS estimates, which is good news, after stopping them for the last six months.  Reuters shows that its 6 contributing analysts ranged from a high of 25.0% to a low of 12.0%.

 

** FactSet shows that its 6 contributing analysts ranged from a high of 25.0 to a low of 15.0%

 

** I usually chose either the very lowest estimate (12.0% from one Reuters analyst) which I considered untrustworthy compared to the other estimates, or the average less 1 Standard Deviation (17.93%) which Excel calculates for me.  Here, I continued to use 15.0% which continued to be FactSet’s low estimate.

 

– To determine the Forecast High and Low PEs, I used the Alt-M command in my Toolkit 5 software.  Alt-M is usually the most conservative option and averages the five lowest High and Low PEs in the last 10 years.

 

** Because QSII’s Value Line report contains no High Price estimate, which I always use as guidance for my SSGs when it is available, I’m especially willing to rely on Alt-M to give me a conservative result.

 

** The Online SSG does not offer Alt-M as an option and this is another area where the software is superior.  Of course, Alt-M could have been calculated by hand and offered to the participants.

 

– My final SSG satisfied the Buy criteria while my initial one did not, even though my judgments were essentially unchanged.  That’s because QSII’s price fell some $7.00 per share in less than two months.

 

(C) The Forecast Low Price

 

– In this recessionary market, with stock prices falling so much in 2008, the SSG’s Forecast Low Price in the next 5 years is perhaps the most difficult and troublesome judgment call: no one can meaningfully “forecast” how much further prices will fall and/or when they will turn up.

 

** Jim’s Low Price ($26.10) was much higher than Ken’s ($21.15) or mine ($19.10), and that is the major reason why Jim’s Upside/Downside Ratio was so much higher. 

 

** Jim chose the Recent Severe Low Price option offered by the software, but not offered by the Online SSG nor by Take Stock.   As a result, Take Stock’s Low Price ($32.30) was even higher than Jim’s and was the highest of all five assessments. 

 

 ** Ken was also limited to one Low Price option, but he chose a Low Forecast PE which then resulted in a low Forecast Low Price.  Note that there was no vote on Ken’s Low Price because, after Ken decided the Low PE and the Low EPS, the Online SSG’s one method to decide the Low Price (Low PE x Low EPS) involves no further judgment and no reason to vote.

 

** I used the same Low Price method as Ken and Take Stock, but got the lowest Low Price ($19.10) because I used Alt-M and thereby also got the lowest Low PE. 

 

** Should prices continue to fall, the SSG software provides an open-ended “Other” option which I can use.  That is, I can choose 60% of the current price, or 70% of the 52 week low, or anything I want for the Forecast Low Price unlike the Online SSG or Take Stock which are limited to only one method.

 

** This raises a serious, conceptual issue: some SSGers think the Forecast Low Price should not be reduced in our recessionary market and should reflect “ordinary” times.  However, the consequences are to get irrationally high Upside/Downside Ratios when the Current Price becomes too close to or falls below the Forecast Low Price. 

 

** Let me know what you think by leaving a comment: would you lower your Forecast Low Price for the next 5 years if it produced a way, way high U/D, say like 99.9 or anything unusual?  

 

– Armin

 

[AF: if you want to read more about QSII, an edited version of the Online Stock Study appears in th 6-7/09 issue of the Better investing magazine]

 

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