One Quality Stock

Is there a company more appropriately named than Motley Fool Stock Advisor pick Quality Systems (Nasdaq: QSII  ) ? Yesterday, the company, which helps smaller medical practices update and manage record keeping with custom hardware and software, enjoyed yet another healthy earnings report.

For its fiscal 2005 second quarter, Quality Systems grew revenue by 20% and net income by 54% over the same period last year. Gross margin continued to improve as well, rising to 63%. That's five percentage points better than last year's 58% and three points better than last quarter's 60%.

Even better, net margin and free cash flow are both on the up. Net margin came in at 18% for the quarter, four points better than last year's second quarter and up a point sequentially. Structural free cash flow is also growing like a weed. Through the first six months of fiscal 2005, cash flow comes in at $11 million. That's more than 30% better than the year prior.

Yet as good as those numbers are, what I love most about Quality Systems is how boring it is. I mean, seriously, this company is an absolute snoozer, just like spice maker McCormick (NYSE: MKC  ) or clothier Men's Wearhouse (NYSE: MW  ) . Just check out this home page. Then look at the quarterly earnings release. For an old PR guy like me, this utter lack of spin is both disturbing and hugely encouraging. Disturbing because it makes me wonder whether executives actually get how good their story is. Encouraging because it indicates methodical, conservative management insistent upon continued gains for shareholders.

That's not to say there aren't risks with this stock. Doctors and dentists could get pinched and decide to stop spending on information technology. Or competition could heat up. But neither seems to be an immediate threat. The real question is whether Quality Systems' stock is still a value at $54 per share. Let's have a look.

When Tom Gardner first picked Quality Systems for Stock Advisor subscribers, he estimated free cash flow growing at 20% to about $16 million by the end of fiscal 2004. I'm happy to report Tom was a little too conservative. In an interview this morning, he said that he now estimates free cash will be $18 million for all of fiscal 2005. The market isn't slowing either, so Tom's estimated 20% growth for the next five years -- below Street estimates -- may still be conservative. Yet at that rate, we'd still be looking at $45 million in free cash by 2009. Applying a 25-times multiple to that total, and adding in the firm's $60 million in cash, creates a revised fair value of $1.2 billion in five years. Even at 1.5% dilution that still makes Quality Systems a $170 stock, or enough to generate better than 25% annual returns from here. Now that's what I call quality.

For related Foolishness:

  • If you think there's money to be made in little guys such as Quality Systems, you might want to check out these three tools for small-cap success.
  • Quality Systems was also a picture of health in May.
  • Not all health care companies are created equal. Some, such as WebMD (Nasdaq: HLTH  ) , look weak.

Quality Systems is one of Tom Gardner's many winning picks forMotley Fool Stock Advisor. In fact, he thought the company was so nice he picked it twice, and it's more than doubled in value since. Don't wait to get in on the action. A risk-free, six-month trial is yours for the asking.

Fool contributor Tim Beyers is a sucker for companies with quality earnings, but, alas, he doesn't own shares of Quality Systems nor any other company mentioned in this story. You can view Tim's Fool profile and stock holdings here.


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