One of the greatest stock pickers of our generation has been largely misunderstood.
The stock picker, is Peter Lynch who ran the wildly successful Magellan Fund for Fidelity from 1977 to 1990. His fund is one of the most famous of its kind of all time with probably the best 13 year track record during the time he was running it. Lynch compounded capital at 29% annually during this incredible run, and his fund grew from $18 million to $14 billion by the time he signed off.
Many consider his most famous investment principle to break down to 5-words, “Invest in what you know,” a concept which helped popularize the economic concept of “local knowledge”.
However, the catch phrase which is so often associated with the famous investor at best completely oversimplifies and at worse misrepresents his true philosophy. Lynch recently confirmed as much in a Wall Street Journal article.
“I’ve never said, ‘If you go to a mall, see a Starbucks and say it’s good coffee, you should call Fidelity brokerage and buy the stock.’” – Peter Lynch
In the brief but concise piece, Lynch basically tells Journal readers that people are misinterpreting his advice to “buy what you know”.
So what have many market participants been missing?
Lynch mentioned at the end of chapter four in Beating the Street how good of a market it was in the early 1980’s.
“The stock market fell apart. As is so often the case, just when people began to feel it was safe to return to stocks, stocks suffered a correction. But Magellan managed to post a 16.5% gain for the year (1981) in spite of it. No wonder Magellan had a good beginning. My top 10 stocks in 1978 had P/E ratios of between 4 and 6, and in 1979, of between 3 and 5. When stocks in good companies are selling at 3-6 times earnings, the stockpicker can hardly lose.” – Peter Lynch
So Lynch in the early years was buying bargains, not just shares in companies he happened to have positive contact with.
His investment philosophy and success was also partly a product of the market conditions at the time he began employing funds and his penchant for growth and value – both of which were in plenty supply for much of his time at the helm of the Magellan Fund.
Lynch preferred growth stocks. It’s just that he wanted to buy them at a fair price – GARP. But he was always on the lookout for the potential 10-bagger, another phrase he coined. Some of the stocks that made the most returns for Magellan shareholders were these big winners that played out over multiple years. And Lynch is right in that 2 or 3 of these huge winners (the Walmarts, the Cracker Barrels, the Wells Fargos, etc…) can make a career. So for good reason, Lynch trumpets the merits of looking for these home runs. But while he himself was always on the lookout for them, he also was buying bargains and special situations when they were available.
We agree with this philosophy. We are always on the lookout for bargains and special situations.
But we do see the merit in marrying a recognizable trend or business we know with GARP. But 2016 is far from the late 70s and early 80s when great growth stocks could be had for between 3 and 8 times earnings. Today, the average PE on the S&P 500 is between 2.5 to 5.5 times those figures. And with 5 solid years of returns in a row and yields elsewhere at historic lows, investors have hardly cast aside the stock market.
So when we uncover a stock that is trading at less than a market average PE, which holds a strong track record of growth and operates in a business we can understand and see a long-term trend of growth – we get excited.
Never before in human history has our planet contained so many older people – or such a large percentage of them. This has not always been the case. As late as 1930, America’s older population numbered less than 7 million – only 5.4% of the population.
Today, one in three Americans is now 50 or older. By 2030 one in five U.S. residents will be 65 and older. One out of every 8 Americans is considered “old” and represent 12.9% of the U.S. population. Those age 65 and older numbered 41.5 million in 2012, a number that has continued to explode.
There is Big Business in Servicing this Demographic Shift
This is a natural conclusion. But the key is to find a business that is profitable and growing and affectively serving a need within this trend.
An aging population will continue to consume health care are rapidly increasing rates. Home health provides the lowest cost care venue because patients are able to stay in their own homes, avoid shifting substantial facility, dietary, housekeeping and other costs to payors.
Patients prefer receiving care in their own home rather than in institutional settings.
The Benefits of Home Health Care include lower cost per day vs. hospital & nursing homes, lower costs to Medicare Program, and it can prevents mild exacerbations from escalating into critical situations
This is a business trend we can understand. The growth is there and if we can find a company to buy at a reasonable price, it might even meet the criteria Mr. Lynch used so successfully in his days with Fidelity.
Initial Coverage: Almost Family Inc.
Client Recommendation Price (March 2016): $36.91
Current Price: $41.53
Near Term: BUY
Long Term: BUY
Founded in 1976, Almost Family is a leading provider of home health nursing, rehabilitation and personal care services, with over 250 locations in 15 states. Almost Family, Inc. and its subsidiaries operate two segments: Visiting Nurse, or VN, which provides skilled nursing and physical, occupational and speech therapy services primarily to Medicare beneficiaries; and Personal Care, or PC, which provides custodial and personal care services. Almost Family’s services are generally covered by federal and state government programs, commercial insurance and private pay. In addition to home health, Almost Family also created HealthCare Innovations (HCI) segment in February 2015 for the purpose of improving patient experiences and quality outcomes, while lowering costs, and responding effectively to changes within the industry.
- Fourth largest home health provider in the U.S. – 232 branches in 16 states.
- Completed a record number of acquisitions over past 12 months.
- $645 million revenue run-rate; implies over 18% growth compared to 2015.
- Proven track record of profitable operation and asset integration; very well positioned to remain a key consolidator within a consolidating industry.
- Strong economic argument in favour of home health care as an alternative to hospital stays.
KEY AREAS OF GROWTH
Management reports being highly optimistic on the current opportunities in the home health sector overall and for Almost Family in particular. Almost Family is now the fourth largest home health company in the U.S., and by establishing itself with a proven track record of profitable operation and asset integration, the company is very well positioned to remain a key consolidator within the a consolidating industry. Acquisitions have been the primary source of growth for Almost Family over the years with the company completing several transactions from 2005 to 2008 and again in the period of 2009 to present.
2015 was the most acquisitive year in the company’s history and management reports a current annual revenue run rate of $645 million which implies over 18% growth compared to reported revenues in 2015. Management believes that industry conditions remain right for a continuing trajectory of Almost Family as a consolidator and market leader with multiple acquisition opportunities remaining for the company.
The long-term demographic trends of an aging population will likely continue to put pressure on federal and state healthcare programs, further forcing governing bodies to explore more cost effective methods of providing services to the public. Home health provides the substantial cost savings compared to hospital stays because patients are able to stay in their own homes and therefore avoid incurring substantial facility, dietary, housekeeping and other costs when hospital stays are not necessary. Almost Family’s Visiting Nurse (VN) segment is designed to shorten or avoid hospital stays for the elderly who have some form of a medical condition that requires some continued treatment. The economics favour a growing focus on home health services; the company reports costs associated with home care in the range of $150 per, day on average, compared to $1,500 per day for hospital stays.
Almost Family is compensated for its home health services by Medicare, Medicaid and other government programs. The rates of reimbursement received by the company are generally dictated by those programs. This reliance on government sponsored reimbursement programs does make the company vulnerable to possible legislative and administrative regulation changes as well as budget cut- backs. This does result in an element of political risk in the company’s business model and can result in significant short-term volatility (in both financial and share price performance) when governing bodies are reviewing their healthcare programs. However, Almost Family has navigated the regulatory headwinds within its industry over the past 5 years very successfully and changes within the U.S. healthcare sector are continuing to drive consolidation of smaller players, from which Almost Family should be a key beneficiary.
FORWARD PE FOR ALMOST FAMILY
Easily one of the most popular readings for value investors, the forward PE ratio shows us the current price of a stock divided by the full year earnings. Generally speaking, value investors like to see this ratio below 20, though it can vary by industry.
Right now, Almost Family has a forward PE of just 14.92, which means that investors are paying $14.92 for each dollar in expected Almost Family earnings this year. Compared to the industry at large this is pretty favorable as the overall space has an average PE of 18.88 in comparison.
Based on Almost Family’s reported trailing adjusted earnings per share of $2.35 the company is trading at a price-to-earnings multiple of 17.6 times. We consider this valuation to be attractive on a 2 to 3 year basis, relative to current valuation levels of the overall U.S. market and when considering the embedded growth in revenue (and earnings) for the company in 2016, the strong momentum behind the business currently, and the favourable mid to long-term economic and demographic trends in the industry.
Almost Family had a transformational year with 2015 being the most acquisitive period in the company’s history. Acquisition activity and organic growth have driven solid increases in earnings and cash flow over the past 2 years. With 6 acquisitions completed over the past 12 months, Almost Family enters into 2016 with run rate revenues of $645 million (18% above 2015 revenues) and operating leverage to drive significant earnings growth over the course of the year. Looking forward, management reports being highly optimistic regarding the current opportunities both for the company and for the home health industry in general. The economics of home health services over hospital stays provides state and federal healthcare programs with a tool to distribute resources efficiently and manage costs in an environment with constrained budgets and an aging population.
The biggest risk we see for the company is regulatory change which has created headwinds for healthcare companies in the past. Almost Family has been very effective so far at navigating these challenges profitably and the company currently sees the regulatory backdrop as stable. What uncertainty in the sector has also done is encouraged consolidation. Almost Family is the fourth largest home health provider in the U.S. and has a track record of successful asset integration which establishes the company as a premier consolidator.
In the near term, the company has embedded growth from already completed acquisitions and solid opportunities to continue the acquisition momentum through 2016. In the long term, we see demographic trends and attractive economics as drivers for growth in the home health space and Almost Family is well positioned to be a key beneficiary of that trend. The stock might even be one Peter Lynch would add to his Magellan Fund were he at the helm today.
For full reports on these companies and more go to www.KeyStocks.com
This author has no positions in any stock mentioned and does not plan to open any positions in any stocks mentioned for at least 72 hours after publication of this article.