Note: All data are as of the close of Friday, November 7, 2014. Emphasis is on company fundamentals and financial data rather than commentary.
The technology and healthcare sectors are generally regarded as outperformers in a low-interest rate environment, since they are capital intensive sectors with enormous research and development budgets and are greatly advantaged by low interest rates which help finance their development programs at a lower cost.
The healthcare sector in particular has a second wind blowing in its sails, that of the recently enacted Patient Protection and Affordable Care Act which has made healthcare insurance coverage mandatory or else pay a fine.
Yet in comparison to the other sectors as graphed below, the SPDR Technology Sector ETF (NYSE: XLK) [light gray] and the SPDR Healthcare Sector ETF (NYSE: XLV) [yellow] have only managed to hit par for the course, running only slightly ahead of the broader market S&P 500 index [black].
Even so, tech and health have done pretty well for themselves since the economic recovery began in March of 2009, currently ranking 4th and 5th among the 9 SPDR sectors, bettered only by the discretionaries, the financials, and the industrials.
But what if we combined the two sectors together - technology with healthcare? With low interest rates still helping both tech and health, plus the PPACA boosting many healthcare companies, what type of a hybrid industry would such a union create? The Healthcare Information Services industry - one of the hottest industries on the market.
In the simplest of descriptions:
"Healthcare information services companies engage in the development and marketing of healthcare information systems. These systems include computer-based practice management and electronic health records solutions, as well as management applications and connectivity services." [Source]
The recipe has all the right ingredients:
- High demand for health information record-keeping, given the huge enrollment in medical insurance plans since the beginning of 2014, which already numbers over 15 million new patients with another 10 million expected to be added in 2015, and
- Continuing low interest rates to make health-technology systems affordable for tech companies to develop, and affordable for healthcare companies to purchase and integrate.
It should come as no surprise, therefore, that the two largest U.S. Healthcare Information Services companies - Cerner Corporation (NASDAQ: CERN) and Athenahealth, Inc. (NASDAQ: ATHN) - have been on fire since the recovery began, as noted in the graph below.
Since the economic recovery began in March of 2009, where the S&P index [black] has gained 200%, the healthcare fund XLV [yellow] has gained 200%, and the technology fund XLK [blue] has gained 205%, Athenahealth [purple] has risen 375% while Cerner [beige] has catapulted 560%. The third member of the group - Veeva Systems Inc. (NYSE: VEEV) [orange] has been publicly traded only since October 2013, and has shrunk 25% in its first year.
On an annualized basis, where the S&P index and XLV have averaged 35.29% and XLK has averaged 36.18%, Veeva has averaged -25%, Athenahealth has averaged 66.18%, and Cerner has averaged 98.82% per year!
The future continues to look bright for the health-tech hybrid Healthcare Information Services industry, with earnings growth in the current and next quarters as well as in 2015 expected to beat the broader market's earnings growth by some 2 to 3.2 times, as tabled below where green indicates outperformance while yellow denotes underperformance.
Yet over the longer term, the industry's growth is expected to settle into a more modestly outperforming pace.
Zooming-in a little closer, the three largest U.S. companies in the industry are seen putting in a split performance in the current quarter, with Cerner and Veeva outperforming the broader market while Athenahealth's earnings are seen shrinking, as tabled below. All three are then expected to underperform the market next quarter.
But come 2015 and beyond, all three of our candidates are set to greatly outgrow the S&P's average earnings growth by some 40% more, to as much as 3.1 times its rate.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, Veeva posted the greatest revenue growth year-over-year by a substantial degree, while Cerner delivered the least.
Since Athenahealth's earnings growth is not available, the metric will not factor into the comparison. Thought it is worthy to note that Veeva's earnings growth outpaced Cerner's by 5 times.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, Cerner operated with the widest profit and operating margins, while Athenahealth contended with the narrowest in both, even posting slight earnings shrinkage.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
In returns on assets and equity, Veeva's management team returned the most in both assets and equity with Cerner's team close behind, while Athenahealth's team returned the least, even losing some assets.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, Cerner provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Athenahealth's DEPS over stock price is the lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, Cerner has the cheapest stock relative to forward earnings, company book value and 5-year PEG. At the overpriced end of the scale, Athenahealth's stock is the most overvalued in each.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, Cerner offers the highest earnings percentages over its current stock price in all time periods, where Veeva offers the lowest percentage in the current quarter, while Athenahealth offers it the rest of the way.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, Veeva is projected to deliver the greatest growth overall, while Athenahealth is foreseen delivering the slowest growth overall, with some shrinkage in the current quarter.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe Athenahealth's stock has the greatest upside potential and greatest downside risk, while Cerner's stock is believed to have least upside potential and Veeva's is seen having the least downside risk.
It must be noted, however, that Veeva's stock is already trading below its low target. While this may mean increased potential for a sharp move upward, it may warrant a reassessment of future expectations.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, Veeva is best recommended with 3 strong buys and 4 buys representing a combined 87.5% of its 8 analysts, followed by Cerner with 9 strong buy and 13 buy recommendations representing 73.33% of its 30 analysts, and lastly by Athenahealth with 6 strong buy and 6 buy ratings representing 48% of its 25 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… Veeva, by a couple of key strokes, outperforming in 14 metrics and underperforming in 3 for a net score of +11, followed very closely behind by Cerner, outperforming in 13 metrics and underperforming in 4 for a net score of +9, and finally by sickly Athenahealth straggling well behind, outperforming in 2 metrics and underperforming in 22 for a net score of -20.
Where the Healthcare Information Services industry is expected to outperform the S&P broader market substantially this and next quarters and in 2015, then outperform modestly beyond, the three largest U.S. companies in the space are expected to split perform over the near term, while all three are seen outgrowing the broader market in 2015 and beyond by some 40% more to 3.1 times.
Yet after taking all company fundamentals into account, Veeva Systems stands first among its peers given its highest cash over market cap, lowest debt over market cap, highest current ratio, highest trailing revenue growth, highest returns on assets and equity, highest future earnings growth overall, best mean and low price targets, and best strong buy and buy analyst recommendations - handily winning the Healthcare Information Services industry competition.