Zero To Hero, An Amazing Run For Pro Medicus?

In 2000, Pro Medicus debuted on the ASX with shares at $1.15, now soaring to over $100 in 24 years, captivating investors.

Rarely does a company combine rapid growth, profitability, and dividends. How did Pro Medicus thrive while others faltered or were acquired prematurely?

Pro Medicus was like others in their sector. They had the run-of-the-mill picture archiving and communications software that was standard and undifferentiated from the market.

The pivotal moment came in 2009 with the acquisition that transformed Pro Medicus, rewriting its trajectory and shaping its remarkable journey.

When considering investments, the return on investment weighs heavily. And when you think about that return it does not get any better than Pro Medicus.

In 2009 their acquistion of a small German imaging technology company Visage for US$3.5 million has turned their company into over $10 billion.

The secret to the success of Visage is its ability to let radiologists view reports and large image files from X-rays and other scans, from their mobile within seconds. This enables medical professionals to immediately make diagnostic decisions remotely.

This was truly a game changer in the industry that has a shortage for their professions. The more recent COVID-19 only fueled the neccessity for Pro Medicus technology when remote working became neccessary.

However, prudent investors should always weigh the growth against valuation. Pro Medicus’s rapid ascent comes with a hefty price tag. The crucial question remains: Will it meet expectations?

The Lesson I Learnt From Pro Medicus

Upon encountering Pro Medicus in 2019, my investing journey had just begun. My understanding of individual company investments was rudimentary at best.

It also reminds me of Warren Buffett’s advice that it is “far better to buy a wonderful company at a fair price than a fair company at a wonderful price”.

Back then, conventional wisdom dictated that a high PE ratio implied pricey stocks, while a low ratio suggested affordability. Pro Medicus traded at $25 with a P/E of 50 and so I hesitated and decided to pass on the opportunity.

Yet, I’ve learned not to be too harsh on myself; I was a novice, and was still grappling with the intricacies of PE ratios.

Essentially, PE ratios indicate how much you pay for a business’s yearly earnings. A nuanced perspective suggests flipping the ratio to ascertain the earnings yield—wherein a PE of 50 translates to a yield of 2%.

However, PE ratios alone offer an incomplete picture. A company’s PE can halve if earnings double, or double if profits plummet.

For Pro Medicus, boasting a compounded growth rate of 35% annually, their profits in hindsight doubled every two years, rendering them seemingly undervalued due to their rapid earnings growth.

Fast forward to 2024, Pro Medicus has surged to over $100 per share, with its PE ratio doubling to over 100. The pertinent question emerges: Can Pro Medicus justify its soaring valuation?

Pro Medicus A Cheery Consensus

Investing in the stock market inevitably leads to moments of reflection, where “if only” scenarios play out in our minds. We gaze at a stock’s historical share prices, imagining the wealth we could have amassed.

Yet, hindsight always seems clearer than foresight, as the past is crystal clear while the future remains uncertain. Predicting a company’s trajectory is challenging and our imagination often falls short in the face of uncertainty.

Just like how company’s perform internal stress tests to see how they would hold up against an unfortunate event. Events that could possibly occur probably have never crossed their minds.

Nobody could have predicted planes crashing into the twin towers on September 11. Hardly anyone predicted an abuse to ethical lending practices that caused the 2008 financial crisis. Nor could anyone have predicted a global pandemic in 2020.

So if someone claimed a company would sustain a 20-30% annual growth for over two decades, they will usually be met with skepticism. Yet, outliers like Amazon, Apple, and Microsoft have defied expectations, surpassing even countries’ GDPs in market capitalization.

Pro Medicus, akin to these giants, has maintained a staggering 30% compounded growth rate over the last decade. However, in 2019, its P/E ratio hovered around 50, prompting questions of overvaluation.

In hindsight, those concerns seem unwarranted, as Pro Medicus consistently doubled its earnings every two years. Despite my reservations, its current trading price surpasses $100, leaving me pondering its current valuation.

Warren Buffett’s adage warns against paying a high price for a cheery consensus. With Pro Medicus’s P/E ratio doubling to 100 since 2019 should further scrutiny be warranted?

Pro Medicus Valuation

Lately, I’ve contemplated initiating a modest investment in Pro Medicus, though my sentiments are cautious, reminiscent of five years ago. However, I’d like to believe my analytical skills have since sharpened.

Currently, Pro Medicus appears to carry a hefty price tag, suggesting an expectation of near-perfection to justify its valuation. Any misstep could potentially erode a significant portion of invested capital.

Undoubtedly, Pro Medicus is an exceptional company, worthy of consideration for any investor. Nevertheless, no enterprise warrants an infinite price. When assessing investments, I prefer an asymmetric bet, where the potential gains outweigh the possible losses.

One remarkable aspect of Pro Medicus is its ability to fund internal operations and investments without relying on external financing. Their debt-free balance sheet and stable share count are particularly noteworthy achievements.

Discounted Cash Flow Model

Although predictions are impossible as no individual can predict the future, it is necessary to make one when thinking about a business.

Pro Medicus has been consistently improving their operating margins and also keeping expenses in line to maintain their growth. More impressively their net profit margin sits at 49% which could explain their high valuation.

This net margin also signals that they have a highly sought after product that customers are willing to purchase from them. They have a clear competitive advantage against their peers and if they are able to maintain their market position, they have a bright future.

In the case for Pro Medicus, for them to trade at a valuation of $115 per share, revenues must grow at 35% consistently for the next 10 years. This is while maintaining all their margins at their current levels.

That would also imply a revenue of over $2 billion by 2033, which does not seem improbable if they can continue to win major contracts.

Of course the target price will also dramatically differ from your discount rate. I usually want a return that is better than the average market return of 10%. Which is why my discount rate has been set at 12.5%.

Their current valuation does not seem farfetched given their historic performance. However, Pro Medicus seems to be trading a valuation that expects them to be perfect for many years.

Key Takeaways

• Learning from my initial encounter with Pro Medicus in 2019, I’ve grasped Buffett’s wisdom: quality outweighs price. Despite my novice status, I’ve come to appreciate the nuances of PE ratios.
• The unpredictability of the stock market prompts reflections on missed opportunities. Hindsight often appears clearer than foresight, yet outliers like Pro Medicus prove long-term growth defies skepticism.
• Paying too high a price for a great business can still make it a bad investment. Proper research is warranted for you to formulate your own ideas and thesis on what how you expect a company will perform.

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