Why I Think HMS Holdings Is a Good Buy

| About: HMS Holdings (HMSY)
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Filling out holdings in my Covestor Healthcare Model, I purchased shares of HMS Holdings (NASDAQ:HMSY) on December 16, 2010, at a cost of $63.91. As of December 23, 2010, HMSY closed at $65.65, up $.01 or .02% on the day. I would like to share with you some of the facts about this company that led me to decide to purchase shares and add it to my portfolio.

It is obvious to us all that Health care costs are a large part of our economy and a big cost to businesses and individuals. In fact, this Kaiser Family Foundation report notes that in the United States, expenditures have risen from $714 billion in 1990 to $2.3 trillion in 2008. By 2008, health care spending "...was about $7,681 per resident and accounted for 16.2% of the nation's Gross Domestic Product." HMSHoldings is involved in dealing with these expenditures and thus finds itself in an area of opportunity for its own business.

According to the Yahoo "Profile" on HMS , the company

"...provides cost management services for government-sponsored health and human services programs."

On October 29, 2010, HMSY announced its 3rd quarter results. Revenue for the quarter ended September 30, 2010, increased 35.3% to $80.0 million from $59.2 million the prior year. Net income came in at $11.0 million or $.39/diluted share compared with $8.4 million or $.30/diluted share the prior year. The company went ahead and raised guidance for 2010 from $290 million in revenue and $1.38/share in earnings to $300 million and $1.40/share in diluted earnings per share. Furthermore, the company announced 2011 guidance with revenue expected to increase 23.3% to $370 million, and earnings now projected to increase 24.3% to $1.74/share.

With this 3rd quarter result, the company beat expectations of analysts who had been expecting revenue of $75.4 million and earnings of $.37/share. Thus with this announcement, the company beat expectations and raised guidance both for this fiscal year and the fiscal year to come (2011). This continues to be very bullish for the company and for the stock price.

Examining the Morningstar.com report for HMSY, we can see that longer-term, the company has steadily increased revenue from $60 million in 2005 to $229 million in 2009 and $282 million in the trailing twelve months (TTM). Fully diluted earnings did take a dip from $.36/share in 2005 to $.22/share in 2006. However, since 2006, they have steadily grown to $1.09/share in 2009 and $1.31 in the TTM. Outstanding shares have modestly increased from 22 million in 2005 to 27 million in 2008 and 28 million in the TTM.

In terms of free cash flow, the company reported $5 million in 2005 and $24 million in 2009 and did dip slightly to $20 million in the TTM. Morningstar reports that HMSY has $140 million in total current assets balanced against $26 million in total current liabilities and a total of $32 million of all liabilities. Thus the company could easily pay off ALL of its liabilities with just its current assets several times over. At least from the Morningstar.com perspective, the balance sheet is impressive and the revenue and earnings results are stellar.

Examining the company's Key Statistics from Yahoo, we can see that the company is a small cap stock with a market capitalization of only $1.81 billion. In terms of absolute p/e ratios, the company is very richly valued with a trailing p/e reported by Yahoo at 50.08. The forward p/e (fye Dec 31 2011) is still rich at 37.09. In terms of evaluating the relative p/e in light of the growth expected, the PEG ratio still comes in a bit high at 2.11 (I prefer PEGs between 1.0 and 1.5).

Yahoo reports only 27.56 million shares outstanding with 27.08 million that float. As of 11/30/10, there were 1.78 million shares out short, working out to a short ratio of 10.0. This is above my own arbitrary 3 day rule for significance on short ratios, and thus, may be considered a bullish indicator. No dividends are paid, and the last stock split was a 3:2 split in January, 1996.

Looking at the 'point & figure' chart on HMSY from StockCharts.com, we can see that this company has a beautiful point and figure chart with incredible strength as the stock price has climbed steadily for over two years. If anything, the price is marginally extended above its support levels.

In summary, I recently purchased shares of HMS Holdings based on its recent technical strength, its sustained earnings and revenue growth reports, and its recent announcement of earnings and revenue that beat expectations while the company raised guidance for upcoming results. Financially, the company is loaded with cash, is generating significant free cash flow, and has persistently reported incredible results for the past five years. On the downside, the stock is not an unknown in the market and to purchase shares you do need to pay a premium in terms of valuation, at least as measured by the P/E and PEG ratios.

It is my belief that stock prices ultimately follow the underlying financial results of the company. Thus, I am willing to pay a premium to be a holder in quality companies capable of producing results like this. Lately, it has been hard to identify them, as so many previous consistent players have faltered. HMSY has earned a place in this blog and in my portfolio as well.

Disclosure: Long HMSY.