It’s no surprise that small cap stocks hold the potential for significant returns. However, high potential upside often comes with high risk and price variability, making thoroughly vetting small cap investments essential. That’s what makes Quality Systems, a California based developer of medical information and automation systems attractive (and a top Forbes small cap pick).
Quality Systems (QSII) - The Upside
At first glance, the value proposition makes sense: health care will continue to grow as aging boomers increasingly require additional medical services and products. The key to streamlining this process is leveraging IT to provide and track critical patient information. The company’s NextGen division, which accounts for almost 90% of revenues, has garnered several awards for its Electronic Medical Records (EMR) and Enterprise Practice Management (EPM) systems. These systems allow health care providers to efficiently manage back-office patient, financial, and administrative data. In addition, Forbes ranked the company as the #5 best small company, while Business Week named QSII #19 out of 100 top growth companies.
A quick look at key stock metrics reveals effective management: Trailing Twelve Month (TTM) Return on Assets (22%), Return on Equity (36%) and ROIC (35%) are all well above its peers in the software industry. In addition, a strong Operating Margin (31%), EBITDA margin (35%), and Profit Margin (21%) suggest a well managed and profitable enterprise. Finally, Quality’s management of debt and liabilities appears stellar, as it carries 0 debt (that’s right no debt) and a current ratio of 2.5X. The icing on the cake for stock investors is a dividend yield of almost 3% - much higher than its peers.
The Downside
On the downside, the company isn’t necessarily a deal with a Price / Earnings ratio of 30 (Most Recent Quarter) and a Price / Book ratio of almost 10. Similarly, a PEG of 1.01 suggests the company isn’t undervalued (but then again, it is a small cap growth company). Further, potential investors in this stock should be aware that an SEC investigation into trading practices of an executive on the management team is ongoing, though the company (after conducting an internal investigation) is confident no wrongdoing has occurred.
Conclusion
Despite having some concerns, we like the long term potential of this stock and the prospects for growth in the health care industry. As a result, we’ll add it to our small cap watch list.