This past December, as the guest analyst for Motley FoolHidden Gems, I picked CardioDynamics (NASDAQ:CDIC) as my featured recommendation for the newsletter's subscribers. In the spirit of full disclosure, I own the stock as well and have followed the company closely for a few years.

Since my write-up, an outstanding assembly of cardiologists, other medical practitioners, and serious investors have joined me on the Fool's Hidden Gems discussion board to talk about everything from clinical trials and practical application of the technology to business strategy and company valuation. It's been a remarkable discussion and I encourage you all to take a free trial to the newsletter. This board alone is worth the price of admission.

For those of you not familiar with CardioDynamics, it's a small San Diego company that markets a cardiac monitoring device capable of measuring important heart functions. Its business is a razor-and-blade model, where it sells the expensive monitoring machine as well as inexpensive but high-margin sensors used with the machine.

In our discussions on the board, I've talked about a few things I think are keys to success for the company and the stock, namely:

  • Corporate focus
  • Accelerating revenue and earnings growth
  • Solid financial management

Up until now, CardioDynamics has done a good job of staying focused on increasing market adoption of their technology. The CFO and his team have also done a tip-top job of managing cash flows and all other financial line items. The only thing that has concerned me is the company's ability to accelerate its revenue and earnings growth.

An announcement it made today really shakes up all three key areas for me, so I wanted to walk you through my thought process, which I hope will help you invest better when your companies make similar moves.

CardioDynamics announced the acquisition of Vermed, a small ECG electrode manufacturer in Vermont. In There are some crucial elements to the acquisition that raise all sorts of healthy questions for us as investors:

  1. CardioDynamics bought Vermed for $16.5 million -- $5 million of cash from the company's coffers, $4.5 million in stock (746,000 shares), and a $7 million loan secured from Comerica Bank (NYSE:CMA). At the end of last quarter, the company had $9.2 million in cash and short-term investments on the books.

  2. CardioDynamics reports that the acquisition will be accretive to earnings for the balance of fiscal 2004.

  3. Recurring sensor revenue, a key revenue line for CardioDynamics, will grow to 37% of revenue in 2005. Previous estimates were for sensor revenue to only be 23% of total revenue in 2005.

As an investor, what kinds of questions should you have? The company you own just made an acquisition that has widespread implications for its business, and you need to be able to think critically about it. What's running through your mind? I'll tell you what's running through mine:

  • Did it pay too much for the acquisition? A Vermont newspaper reported last July that Vermed's parent company had $23 million in revenue, but we don't know what percentage of that will come into CardioDynamics' revenue stream. It's hard to tell whether they paid too much. That is definitely one question we want answered in tonight's conference call.

  • What are the implications for the company's balance sheet? With the acquisition, the company depletes its cash reserves by $5 million, increases debt by $7 million, and dilutes the common stock by approximately 1.7%. Will it continue to be able to manage its operations successfully with these changes? My guess is that it wouldn't put the company's liquidity in danger to make this acquisition, but we'll have to see.

  • What are the revenue and earnings implications? Happily, the company reports that the acquisition will be immediately accretive to EPS, which will help boost sensor revenue as a percentage of total revenue. I'd like to know what total revenue will look like with the new company in the fold.

  • What about corporate focus? Vermed's business is deeper than just CardioDynamics' sensors. It also makes neonatal ECG sensors, among other types of sensors. Is CardioDynamics now in the electrode business and not the impedence cardiography business? We'll want to be satisfied with its answer to the whole issue of corporate focus.

  • Anything else we can learn from this? Interestingly enough, the information you glean from one company can have a meaningful impact on other companies you follow. Recently, I shared my opinion that Arrhythmia Research Technology (AMEX:HRT) was significantly overvalued. The company makes the resin sensors found in ECG electrodes, an eerily similar business to Vermed. Today, Arrhythmia Research Tech's market cap stands at $54 million, with $7.67 million in revenue.

Remember, Vermed was bought for $16.5 million, and it has the lion's share of Vermont Medical's $23 million revenue. If Arrhythmia Research Tech were valued similarly to Vermed's electrode division, it'd be trading for a market cap of between $5 million and $15 million, some 70%-90% below where it trades today.

As an individual investor, and as an owner of businesses, you need to hone your analytical skills to be able to understand how important moves made by your companies will affect the share price of the stock over the long haul.

Are you prepared to ask the hard questions and demand answers? You'd better be or your portfolio will suffer for it. I can't wait to hear the conference call this evening and get answers to all of my questions about CardioDynamics. Take that trial to Hidden Gems (it's risk-free) and join me tomorrow on the discussion board as we dissect the news in its entirety.

David Forrest owns shares of CardioDynamics, but holds no position in Comerica Bank or Arrhythmia Research Technology. The Motley Fool is investors writing for investors.