This is the seventh in a series of articles covering the home healthcare industry. See part 1 here, part 2 here, part 3 here, part 4 here, part 5 here and part 6 here.
Facts are simple and facts are straight, facts are lazy and facts are late,
Facts all come with points of view, facts don’t do what I want them to,
Facts just twist the truth around, facts are living turned inside out,
Facts are getting the best of them…(David Byrne’s “Crosseyed and Painless”)
In a way, numbers are the most extreme form of facts, and they too frequently offer a false sense of security. When in a foreign, abstract environment, the brain will search for definition, and the man-made convention of numbers offers a reassuring foothold. Quite to the contrary, the foundation of this series is conceptual in nature, oriented around the business of home healthcare and the markets in which the shares of its public companies trade. Those four very non-conceptual, precision-oriented models from the previous article could prove to be counterproductive.
Warren Buffett has likened eyeballing the weight (value) of a stock to eyeballing the weight of a person. If the simple and singular objective is to accurately identify people who weigh over 200 pounds, then we should look for people who weigh well over 200 pounds. An audience would be awed by a master guesser who, though selecting people on the low side of 200 pounds from time to time, consistently selected 203 and 207 pounders. An audience would be bored to tears by the simpleton who, though always on the high side, only picked really big, fat people who obviously weighed no where close to 200 pounds. The trick is not to be precise (there is no penalty if one incorrectly opines a 350 pound person weighs only 280 pounds), the trick is to be certain the person is over 200 pounds.
The significantly more challenging objective of identifying under-priced stocks is best approached along similar guidelines. If the objective is to buy stocks with a margin of safety, we should try to buy them at as big a discount to intrinsic value as possible. If an investor has the option of buying Stock A at a precise 30% discount to intrinsic value or Stock B at a difficult-to-estimate 50-90% discount, there is simply no question—other things being equal, and if given enough time—which course of action will lead to superior results. As investors, we should strive to be simpletons rather than entertainers.
In this series, we have reviewed compelling evidence that the incredible admissions growth this century within home healthcare has been spurred by systemic changes—evidence that flies in the face of conventional wisdom. These systemic changes are rooted in two obvious and overwhelming features that bode well for long-term shareholders: 1) care at home is preferred; and 2) home healthcare holds the unassailable position as the lowest cost provider of pre-acute and sub-acute care.
Forces— predominantly political and economic—appear to be aligning now that will accelerate what has already been impressive admissions growth. If we humbly admit that healthcare reform may create some unpredictable changes that prove this thesis incorrect, home healthcare is still destined to grow at an impressive clip within the next eight years due simply to demographic forces.
Congress has historically—and wisely—allowed for more than minimal profits via PPS for Medicare providers. Double-digit net margins are always nice, but should never be expected. But even if only minimal profits were allowed, our industry leaders would remain profit leaders. They will continue to consolidate this market for years to come—a result for which those in Washington are cheering, if only to manage a more simplified industry. The executive teams that survived the perfect storm at the end of the previous century know well how choppy reform waters can get. They will navigate cautiously— supremely confident in their proven skills to change tack quickly—and be certain not to drown their companies in debt.
Let us revert from this maritime metaphor to the original weighty analogy. We could say that these publics represent four really big, fat guys who may weigh anywhere from 300 to 1,000 pounds, but who certainly weigh more than 200 pounds. [[AFAM]], our case study, has an intrinsic value—in my opinion—of somewhere between $600M and $1.25B ($70 to $150 per share). Stocks like these usually trade significantly below their intrinsic value; but recently—and for reasons that will persist in the immediate future—the discounts have been too great.
Fat Guy in a Little Coat
Ben Graham once famously stated, “In the short run, the market is a voting machine; in the long run, it’s a weighing machine.” In the fourth article of this series, we reviewed how the votes affecting these stocks at the beginning of this year had severe ramifications in the short term. Though more extreme than usual, this is nothing new.
Hindsight is often used to paint tantalizing pictures of what could have been had one purchased a stock at the exact low point and sold at the exact high point during a given time frame—again, a goal that is unwise to hope to achieve. To be sure, the reader would have a hard time finding a more tantalizing buy-sell scenario over the past decade than AFAM from the autumn of 1999 through the autumn of 2008.
Instead, however, let’s invert that exercise and identify the worst possible scenario during a similar time frame. If one had been so perfectly unlucky as to purchase AFAM at its multi-year high price of $5.38 in October 1997, and sold at the bottom of the bear raid this past March for $14.91, the total return for that twelve-and-a-half year stretch would have been 177%—which is an infinite improvement over the approximate 30% loss one would have taken during that same time period in the S&P 500.
Had an investor done such a poor job of timing, his first two and a half years—had he focused solely on stock quotes—would have been mentally debilitating: $100,000 invested in AFAM in October 1997 would have turned into about $37,000 by the Spring of 2000. It is easy for us to take all of ten seconds to read the previous sentence and dismiss the investor’s self-induced 29 months of misery because we know that since he held on, all is right with the world. In fact, we think it a pity the investor didn’t buy more during that 29-month stretch.
That same investor might dare us to be so bold with our own money today as we stare into the dense fog of the future. If we buy these stocks fully aware of the long-term opportunities, then we can regularly reflect on the intrinsic value of these companies (or go on a sabbatical to the Congo) rather than focus on erratic and inefficient stock market quotations in the short term.
All of these publics are relatively small companies with limited institutional ownership and low (though vastly improved) trading volume. Their rag-tag group of shareholders is tossed up and down the valuation hierarchy regularly.
Last November, Deutsche Bank analyst Darren Lehrich downgraded AMED, an act which played a very meaningful role in the stock falling from $54 to $38 in five days. Investors interested in these companies should pay close attention to two telling features of this story. First—and of least importance—Lehrich offered concern over AMED’s receivables as his reason for the downgrade. His opinion was admirably unconventional.
AMED, of course, lives and dies by Medicare—which regularly affords a litany of potential reasons for a downgrade. However, as it is federally funded, Medicare reimbursements come from the single most deep-pocketed entity in the world, which prints its own fiat currency. One could easily argue that since these companies have no pricing power, our fiat currency might eventually create severe problems, as market-driven and inflated costs and expenses may outweigh watered-down revenues (i.e., slow-to-increase governmentally-dictated revenues worth less in real dollar terms). Mr. Lehrich simply questioned whether or not AMED’s receivables will be collected, without giving any other reason(s) or explanation for the downgrade.
The second—much more incredible—telling feature of this story: his inexplicable downgrade flattened the stock.
If our publics can be viewed as four fat guys, then we should be fully prepared for some clever tailors periodically dressing them up in little coats. The tailors, essentially, are attempting to take advantage of our credulity. They are trying to trick us—the relatively unsophisticated home healthcare investing community—into believing that these are four rather thin men. Some of the coats will be of superior craftsmanship, but none of them will last longer than a couple of years: Our publics will tear through these feeble facades time and time again.
In conclusion, we should accept a self-evident reality: These stocks are not for faint-of-heart traders. Brave traders can attempt to benefit from the tremendous stock price fluctuations our four publics offer, but there is simply no surer bet than to go long at today’s discounted prices—and generally ignore the market for several years. Because of the vagaries these companies’ businesses and stock prices are subjected to, we should periodically look for opportunities to decrease our average purchase price. Significant (or even hypothetical) reimbursement cuts, bear raids or analyst downgrades all provide such opportunities. Bad news can be the value investor’s best friend.
