RealMoney

It is going to be a big week around my house this week. The American Bankers Association Conference for Community Banks is here in Orlando, so I will be in and out of that gathering. I will be catching at least one live baseball game as spring training kicks off in Florida. As I enjoyed the calm before the storm this weekend, I spent some time reading some of the private equity firms' SEC filings and websites. One thing I find very interesting was that all of them are starting to focus a bit more on health care. You may recall that last Thursday I focused a bit on KKR's (KKR) purchases in the sector in the fourth quarter.

Health care has been under-represented in my portfolio for as long as I can recall. In major crashes such as 2001-2002 and 2008 I have had the chance to pick up some of the big pharma dividend payers on the cheap, but most of the time health care stocks that are in equipment and services never fall into my valuation range. I avoid most biotech stocks because I am well-aware that I am nowhere near smart enough to understand these companies. For those reasons, I always have been somewhat health care light.

That probably has been a mistake on my part. While I will continue to avoid biotech for reasons of low intelligence, I can with some research and digging find ways to get money into the health care sector on private equity-like terms that can satisfy my inner Ben Graham and still participate in the long-term growth of this industry. The big private equity firms have somewhat of a value bent, so I should be able to put something together that allows me to be a value-oriented health care buyer.

The first thing I have to do is stop using book value in the sector and switch my valuation metric to enterprise value/EBIT (EV/EBIT). That's a more useful measure for this sector. Indeed, my research is showing that it is more often than not the best metric for all non-financial sectors.

Health care stocks always have fetched a premium multiple, so I will relax my limits a bit and limit my search to those medical equipment, services and technology companies to multiples of 10x or less. That's about two-thirds the current market multiple and slightly below where the average buyout deal is done at these days.

To make sure we are not buying a bad business with poor prospects, I then further limited my search to those companies that earn a Piotroski F-score of 6 or higher. I did a quick and dirty back test of the parameters and found that the combination handily beat the market since the start of the new century.

The resulting list is not a long one as we are eight years into a bull market, but there were a few ideas that appear to be medical stocks a value investor could love.

Fonar (FONR) makes MRI machines and also has four diagnostic imaging facilities in Florida; it also manages 25 MRI scanning facilities, which includes 18 in New York and seven in Florida. According to Fonar's website, it is the oldest magnetic resonance imaging (MRI) company in the industry and its chairman, Dr. Raymond Damadian, is the inventor of the scanning device. Business is pretty good right now, and Fonar's most recent earnings report showed solid gains in revenues and profits. Best of all, the stock looks cheap here, with an EV/EBIT ratio of just 7.3. The F-score is a solid seven, so the company is in decent financial shape with solid prospects.

The thing that interested me about this company is its Upright Multi-Position MRI scanner. I have had a few MRIs over the years, and I can tell you I hate being in that tube. This new scanner allows patients to sit upright and watch TV or read a book while the scan is done. It also allows the scan to be done in full weight-bearing position, which can be very useful when examining the back or spine under the stresses they might experience during normal activities.

The company has some exciting products under development as well. The OR-360º is a room-size MRI that will allow surgeons, along with their assistants and equipment, to operate without obstruction inside the scanner's magnet using the imagery provided in real time as they work. Fonar also is working on technology for visualizing and quantifying the cerebral hydraulics of the central nervous system. Both of these developments could be growth drivers in the future.

As usual, I have run out of room to talk about the other medical companies that pass my basic value/private equity screens. This is all very much a work in progress, but health care is a source of potential 100-to-1 ideas, so finding a way to uncover those with huge potential at bargain prices is worth a little time and effort.