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Stock Picks Bob's Advice
Tuesday, 12 September 2006
Psychiatric Solutions (PSYS) September 12, 2006

Hello Friends!  Thanks so much for stopping by and visiting my blog, Stock Picks Bob's Advice!  As always, please remember that I am an amateur investor, so please remember to consult with your professional investment advisors prior to making any investment decisions based on information on this website.

It is a nice change to be looking at a stock market moving ahead strongly on the back of additional gains in the prior weeks. We have had so many days and months of corrections as the Fed relentlessly pushed interest rates higher.  Perhaps most of that weakness is behind us. In any case, with the market indices moving ahead all day today, we have the opportunity of finding additional companies that are worth evaluation on this website.

My method of identifying candidates for consideration continues to start with the top % gainers list.  Why?  Well, if we wish to identify a timely stock that will move higher from this point in time, why not start with stocks moving higher today?  In any case, using this list gives us a manageable group of names to evaluate.

In fact, looking through the top % gainers list from the NASDAQ today, I came across Psychiatric Solutions (PSYS), which is, as I write, trading at $35.78, up 10.91% on the day.  I do not have any options or hold any shares in this company.

I have already examined this stock for myself, but let me share with you why I believe it deserves to be on the blog.

1. Is there any news to explain the company's move higher? 

As reported, it was announced after the close of trading yesterday that PSYS will be replacing RSA Security in the S&P MidCap 400 Index.  Since there are investment vehicles like the iShares MidCap 400 Index fund, this means that individuals or institutions that are trying to reflect the performance of this index will be more or less 'swapping' shares of RSA to buy shares of PSYS. In any case, this recognition by the S&P people, also is helpful in bringing this stock to the public's attention and the stock price responded nicely today.

2. What exactly does this company do? 

Checking the Yahoo "Profile" on PSYS, we find that the company

"...and its subsidiaries provide inpatient behavioral health care services in the United States. The company operates in two divisions, Inpatient and Inpatient Management Contract."

3. How did they do in the latest quarter? 

On July 26, 2006, Psychiatric Solutions reported their 2nd quarter results.  For the quarter ended June 30, 2006, revenue came in at $248.4 million, up 78% from $139.5 million reported in the prior year same period.   Net income increased 38% to $.29/share up from $.21/share last year.  Just as in retail evaluations, we can talk about "same-store sales growth", since this company may have sales affected by opening new hospitals, or acquiring hospitals which has occurred, the "same facility growth" is important and PSYS noted that the 'same-facility revenue' increased by 8%.  

An additional note in the earnings report was the raised guidance for the 2006 fiscal year from the previous $1.02-$1.05 to a new range of $1.08-$1.10.  Since analysts had been expecting $.27/share on revenue of $248.4 million, this result also beat expectations by $.02.  This is what I call my 'trifecta-plus' in earnings reports: increasing revenue, increasing earnings, beating expectations, and raising guidance--a nice combination that imho often tends to precede stock price appreciations.

4. What about longer-term results? 

My favorite place to examine longer-term results if Morningstar.com, and the "5-Yr Restated" financials on PSYS look superb. What do I mean by that?  What I am searching for in my quest to identify stocks worth of investment is quality.  For me quality in an investment is defined by a consistent pattern of financial results including steadily increasing revenue, earnings, and positive and growing free cash flow.  This should be done without diluting the equity by issuing an abundance of shares and without a perilous balance sheet.

Looking specifically at Psychiatric Solutions, we can see the rapid growth in revenue as represented by the series of increasing purple bars on the graph, from $44.0 million in 2001 to $727.8 million in 2005 and $944.7 million in the trailing twelve months (TTM).

Earnings have grown from $.22/share in 2003 to $.82/share in the TTM.  Unfortunately, the company has been a bit liberal with issuing shares growing the shares outstanding from 17 million in 2003 to 53 million in the TTM.  In spite of the tripling of shares with the tripling of revenue, the company has still been able to almost quadruple earnings pere share.  

Free cash flow has been positive, increasing from $13 million in 2003 to $23 million in 2004, $58 million in 2005 and $80 million in the TTM.

The balance sheet is o.k. with $56.5 million in cash and $195.3 million in other current assets. This total of $251.8 million in current assets, when compared to the current liabilities of $101.6 million yields a current ratio of 2.48.  I have generally followed the 'rule' that a current ratio of greater than 1.5 is considered 'healthy'.  Clearly, the company does have a significant amount of long-term debt; apparently financing its rapid growth through both the issuance of stock and borrowing, but the presence of a solid and growing free cash flow with a healthy current ratio suggests that this debt will be handled satisfactorily in the immediate future.

5. How about some valuation numbers on this company? 

Reviewing the Yahoo "Key Statistics" on PSYS, we find that indeed this stock is a mid-cap stock with a market capitalization of $1.91 billion.  There are many definitions for market capitalization, but this one from the Investopedia states:

"Mega Cap: Market cap of $200 billion and greater
Big/Large Cap: $10 billion to $200 billion
Mid Cap: $2 billion to $10 billion
Small Cap: $300 million to $2 billion
Micro Cap: $50 million to $300 million
Nano Cap: Under $50 million"

 The trailing p/e is a fairly rich 43.93, but the forward p/e (fye 31-Dec-07) is a more-reasonable 25.34.  Thus, the PEG ratio (5 yr expected) is a very reasonable 1.19.

Reviewing the information from the Fidelity.com eresearch website,  we can see that PSYS is in the "Specialized Health Services" industrial group.  Looking at the Price/Sales ratio, as Paul Sturm explained in Smart Money, relative to other companies in this group, PSYS is reasonably priced with a Price/Sales ratio of 1.9.  Leading this group is another favorite of mine, Healthways (HWAY) with a Price/Sales ratio of 4.6.  This is followed by United Surgical Partners (USPI) with a ratio of 2.4, then PSYS at 1.9, then DaVita (DVA) at 1.9, VISTACARE (VSTA) at 1, and Caremark Rx (CMX) at 0.7.

 Reviewing the Return on Equity (ROE), for a measure of profitability, PSYS also is low on the list with DaVita leading the list at 24.3%, Healthways at 13.6%, Caremark Rx at 12.7%, United Surgical Partners at 9%, Psychiatric Solutions at 7.9% and VISTACARE at the bottom of the list at -6.6%.  

Thus from these two meaures, PSYS is average-priced in terms of Price/Sales for a relatively less profitable business.  Apparently, in light of the rapid growth in both revenue and earnings, investors have been willing to pay a premium for these shares.

Finishing up with Yahoo, we can see that there are 53.13 million shares outstanding with 5.86 million shares out short.  This is a hefty short ratio of 8.1 representing the 5.86 million shares or 11% of the float.  It may well be, that in the light of relatively good news today, that the shorts were squeezed, pressuring the stock price higher.  But that is of course just my speculation on today's move.

No cash dividend is paid and the last stock split was a 2:1 split earlier this year on January 10, 2006.

6. What does the chart look like? 

Looking at a StockCharts "Point & Figure" chart on PSYS,  we see an incredibly strong chart of a company that was consolidating from January, 2001, through February, 2004, when the stock broke through resistance at $4.00 and start an ascent into the $36 range where it is now trading.  The stock was pulling back a bit since February of this year, but after its big move today is once again heading into new highs territory.


7. Summary: What do I think about this stock?

To summarize, the stock had a large move higher today on the back of good news about its inclusion in the S&P 400 MidCap index.  On top of this, there are a large number of short-sellers who may well have been taken unawares and 'squeezed' with this price rise adding to the buying pressure.  In any case, the last quarter's report was solid, the Morningstar.com report is good except for a bit of long-term debt and the habit of this company to issue new shares to fund its activities.  Value-wise the company's p/e is rich in the 60's, the PEG however is reasonable under 1.2, suggesting that the prospects may well justify the premium.  Both Price/Sales ratios and ROE are unimpressive, again suggesting fairly rich valuation.  Finally the chart is strong and may in fact be a bit over-extended.  However, with all of the other criteria met, this is the kind of stock I might be adding to my portfolio, if I had a signal to be buying in the market at all!

Thanks again for stopping by and spending some time here on the blog.  If you have any comments or questions, please feel free to email me at bobsadviceforstocks@lycos.com and be sure to listen to my Stock Picks Podcast

Bob 


Posted by bobsadviceforstocks at 3:10 PM CDT | Post Comment | Permalink
Updated: Tuesday, 12 September 2006 4:00 PM CDT

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