Behold the fool saith, "Put not all thine eggs in the one basket" -- which is but a manner of saying, "Scatter your money and your attention;" but the wise man saith, "Put all your eggs in the one basket and -- WATCH THAT BASKET." -- Mark Twain

That quote, one of my all-time favorites, hits on what I believe is perhaps the most under-appreciated investment paradox: You reduce risk by concentrating investment capital and investment research into your best opportunities. I'll not make a tangent of it now -- since I already have before -- but suffice it to say the advantages of investment concentration are why I believe that, oftentimes, the best "new" investment idea is already in your portfolio.

On the basis of that thinking, I recently added to my already-sizeable position in Quality Systems (NASDAQ:QSII). This company is a small but important part of an information revolution taking place in our nation's health-care system. Specifically, Quality Systems provides a software-based solution for almost everything a physician or dentist currently does on paper -- resulting in improved quality of care at a lower cost.

At a valuation of 18 times free cash flow, Quality Systems may not initially seem to fit my value philosophy. But the key value ingredient here is growth, delicious growth. In order to understand this growth potential, some industry background is in order....

Fertile ground for growth
For reasons I don't fully understand, health care as an industry has historically been slow to adopt information technology (IT). And where the industry has invested in IT, it's primarily been for administrative, not clinical purposes. In other words, your doctor may have a computerized record of the date of your next appointment and how much you owe from the last visit, but your medical (i.e., clinical) information is probably on a piece of paper, tucked into some color-coded file. Yeah, the file your nurse was scribbling on while she laughed at another nurse's joke.

It's that bad. Clinical patient information, as it exists today, is largely a paper system of handwritten and typed notes. These old-fashioned patient charts cannot be accessed, aggregated, or organized electronically, and therefore are frequently unavailable for patient encounters. Furthermore, studies have found that data within these paper charts is frequently inaccurate or incomplete. It's no wonder that six out of every 100 hospital admissions result from an adverse drug event, of which 28% were preventable.

In sum, paper-based clinical records are a disaster waiting to happen. For the patient, there's the obvious risk of improper care. But there's also huge risk for physicians -- the risk of a malpractice lawsuit, which can arise if a patient's chart doesn't contain complete and proper notation.

For all these reasons, physician practices are long overdue for an information overhaul. But until recently, the technology was either too complex or too costly to be practical. The vast majority of physicians are in solo or small group practices, where there tends to be a short supply of necessary financial resources and IT implementation know-how.

But all that's changed over the past few years, as the price/performance quotient for technology has finally dropped to a point where clinical software is viable for even small physician practices. Key to this milestone has been the development of practical software features, such as modular components (i.e., smaller, less expensive units of software), user-driven customization, and intuitive navigation, all of which shorten the implementation and learning curves.

From a product lifecycle perspective, early adopter medical practices have successfully used clinical software for several years. With their success stories and the continual price/performance improvement, the stage is now set for the much larger wave of early majority practices to come on board.

How large? According to Jerome Carter, M.D., author of Electronic Medical Records: A Guide for Clinicians and Administrators (2001), less than 6% of all medical clinics are currently utilizing clinical automation technology. It's safe to say that the market is easily less than 10% penetrated.

EMR: Electronic Medical Revolution
The key component to any clinical software system is the electronic medical record (EMR). This is the computerized version of a patient's chart, plus a whole lot more. An EMR will typically include the following components:

  • Patient's history -- including past encounters, medications, procedures, referrals, and vital statistics;
  • Transaction capability -- such as ordering of laboratory tests, medical procedures, and prescriptions; and,
  • Administrative functionality -- including invoice generation, payment requests, payor documentation compliance, and clinical research data compilation.

As you can imagine, EMR allows for vastly improved quality of care with increased operational efficiency. Achieving those two goals is health-care nirvana.

And if the natural benefits aren't enough cause for EMR demand, there's a legislative tailwind from the Health Insurance Portability and Accountability Act (HIPAA). HIPAA's complex requirements, some of which will go into effect this year, make an EMR system a near necessity.

Some of HIPAA's requirements, such as patient privacy and security, can be met through fixes and patches to older technology. But HIPAA's transaction requirements -- which require the capability to process electronic insurance claims -- necessitate a ground-up approach. A natural solution is a 100% HIPAA-compliant EMR system, such as the one offered by Quality Systems.

Where does Quality Systems fit in?
Quality Systems, through its NextGen division, is the top provider of EMR systems for physician practices. The company claims a competitive advantage by having "the most flexible software on the market, bar none." Part of this flexibility is its interoperability with 26 outside vendors' physician practice management systems (PPMS; i.e., administrative health-care software). Given that PPMS is an older, more penetrated market, the compatibility of Quality Systems' EMR package is a major selling point.

Quality Systems' sparkling financials confirm its claims of competitive advantage. In calendar 2002, the company racked up sales of $51.7 million, marking growth of 19.8%. Free cash flow for the year was $8.8 million. As a steady cash producer, the company has accumulated a bank balance of $33.1 million and no debt.

Next week, I'll pick up here and tell you about some of the exciting news that came out of the company's most recent conference call. I'll also take a stab at gauging Quality Systems' 10-year growth potential based on the projected size of the EMR market.

Off the cuff...
A quick followup to last month's article on Hasbro (NYSE:HAS).... Shareholders received a victory on Friday with news that the company's board of directors will be elected each year instead of every three years. By eliminating the staggered director terms, shareholders will have the opportunity to kick out the entire board if they ever so choose. This helps prevent a board from becoming too entrenched -- something that happens all too often in corporate America. A Foolish tip o' the hat to Hasbro's board!

Matt Richey (MattR@fool.com) is a senior analyst for The Motley Fool. At the time of publication, he held shares of Quality Systems and Hasbro. For Matt's best stock ideas and exclusive in-depth analysis each month, check out our newsletter, The Motley Fool Select , where Quality Systems was originally presented in June 2002. The Motley Fool is investors writing for investors.