The Search for Compounding Machines on GuruFocus
**EDIT: On December 10th, 2014 Nintai established a LONG position in CPSI. At the time of writing this article Nintai had no position in the company.**
Many readers of GuruFocus have asked us over the past few weeks how Nintai goes about finding candidates for our investment portfolio. We believe we live in an extraordinary time when such resources like GuruFocus are available to us. The ability to obtain, read, and compare 10-Qs at the click of a mouse, visit a company's website or read feedback from a company's customer base - all without leaving your office - is a huge advantage to modern day investors.
That being said, the ability to find hidden gems with mispriced valuations is increasingly difficult as every competitor of Nintai's can utilize these same resources. It is because of this that we feel it is critically important to always evaluate our investment process. Ultimately, we must find the most effective ways to locate stocks that the markets have fundamentally misunderstood - either through competitive strength, missed revenue goals, badly executed operational performance, or simply market timing - and patiently await until the markets buy into our thesis. With all of the data and information available to the investment community, we find we must be incredibly focused to find these opportunities and execute on our strategy successfully over and over again.
On the Hunt with GuruFocus
So what tools do we use on GuruFocus to help us identify potential investment opportunities? As we’ve mentioned previously, there are certain criteria we look for in which we are extremely unwilling to sacrifice, even in very compelling situations. These include[1]:
Competitive Moat
First, we look for companies with existing – and hopefully - expanding competitive moats. We believe there are two fields that allow us to screen for this. First is the 10-year median Return on Capital. For this field we put in a minimum of 15%. Second is the 10-year median Return on Tangible Equity. Here we again enter 15% as a minimum. We believe a company that can achieve this hurdle has a proven and demonstrable competitive advantage or moat. When we run these as the only two conditions we reduce the total companies eligible to 2586.
Financial Strength
Our next criteria are to make sure the company has a rock solid balance sheet. To test for this, we use two additional fields. The first is Cash to Debt. Here we put a minimum value of 100. The second field is Financial Strength with a minimum value of 9. We believe this identifies companies with the capability of withstanding any type of emergency or investment necessary in their respective business. When we run the competitive moat fields with financial strength (four fields in total), this reduces the total companies eligible to 60.
Profitability
While the company needs to be financially strong we also want it to be extremely profitable. Utilizing the Profitability field we enter a minimum of nine. This assures the company also has an uptrend in profit margins. We run the Financial Strength, Competitive Moat, and Profitability (five fields in total) criteria we are left with a total of 7 companies.
Undervalued
Once we run this report, we sort the companies utilizing the Valuation tab below the All-In-One Screener. This allows us to measure the value of the company by three (3) different discounted cash flow models: cash flow based, earnings based, and free cash flow based.
Results
Of the seven (7) companies remaining we are interested in particular in one – Computer Programs and Systems (CPSI, Financial). The company provides healthcare information technology solutions to rural community hospitals with over 650 client hospitals in 46 states and the District of Columbia. The company designs, develops, markets, installs, and supports computerized information technology that address the specific needs of small and midsize hospitals. The company's software applications are grouped for support purposes according to the following functional categories: Patient Management; Financial Accounting; Clinical; Patient Care; and Enterprise Applications.
The company has increased earnings per share from $0.67 in 2004 to $3.23 (EST) in 2014. Free cash flow has grown at 8.9% for the last 10 years, 34% the past 5 years, and 72% over the last year rising from $9.3M in 2004 to $40M in 2014 (EST). The company carries no debt and has $28.7M on the balance sheet.
The company has averages roughly 42% return on tangible equity for the past 10 years and roughly 129% return on capital for the same period. Finally, the company pays a hefty 3.9% dividend. A compounding machine indeed.
The obvious fly in this particular ointment is the company is not nearly undervalued enough to initiate a position. However, this company will likely be placed on our watch list and we will develop a complete financial valuation work up on the company. Should we believe this company deserves a place in our portfolio, we are happy to wait for Mr. Market to make his appearance and make us an offer we can’t refuse.
Conclusions
GuruFocus allows us to quickly – and in remarkable detail – search for companies that meet our investment criteria. While these aren’t for everyone, we believe the process has provided our investors with generous returns over the past 10 years. With GuruFocus, we feel comfortable we will make some investment decisions which will continue – over the long term – to exceed market returns. Next week, I will use several investment cases in which we were entirely incorrect and explain how and why we misjudged our companies so wrong.
[1] Please note search results are based on November 17th, 2014 results.
