Why is the Pro Medicus share price up 2,100% in 5 years?

Will Pro Medicus Limited (ASX:PME) shares take a breather in 2019?

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The Pro Medicus Limited (ASX: PME) share price printed a record high of $17.12 in trade today and the software-as-a-service medical imaging business is now up a vertiginous 22x (2,100%) in just 5 years.

I must admit to getting on board this runaway train a little late first buying the stock for $7.68 back in November 2017 despite regularly writing and tweeting about its potential in the preceding years.

Embarrassingly, I still only a hold a small stake that is not really material to my investment returns, after failing to add to the position despite its obvious potential.

So let's take a look at a few reasons why the market is now waking up to Pro Medicus's potential.

Firstly, we have to face the fact that there aren't many high-quality tech businesses on the local market and the Pro Medicus pile on is partly because local fundies face a dearth of other quality tech options.

Next is the fact that the group released a 'market update' this morning that is likely encouraging the buying from forward thinking investors.

In fact the most appealing aspect of the business is its potential to keep growing strongly for many years given it boasts market-leading tech products in a healthcare space that is extremely lucrative for any successful service provider.

Moreover, Pro Medicus is a healthcare service provider that is capital light, scalable, with a relatively fixed cost base and rising profit margins. Compare that to a medical staff locum provider for example, that operates on thin profit margins, or a capital swallowing hospital operator such as Ramsay Health Care Limited (ASX: RHC).

And when I say it's in a lucrative space I'm not kidding.

It recently signed a $27 million 5-year service deal with Partners Healthcare which is just a single healthcare provider in the U.S. state of Massachusetts.

Partners Healthcare is also a market leader containing the "top two" teaching hospitals for Harvard Medical School and if a single contract is worth this much it's obvious Pro Medicus has potential to grow in huge addressable markets. It is also just scratching the surface of its sales potential in Europe and the Asia Pacific region (Australia, etc),

All of this as its radiology information system (RIS) software is well positioned to help the migration of healthcare providers to mobile and intelligent digital or electronic health diagnosis, alongside record keeping.

As such its market-leading software appears to provide it some pricing power and competitive edge – as so far competition in the space has been relatively benign. Famous investors such as Warren Buffett and Charlie Munder have often claimed 'pricing power' is the single most important quality for a company to become a great investment.

Finally, if like me, you place a lot of emphasis on management alignment in buying shares then the founder-led Pro Medicus also ticks the boxes as its founder and CEO Sam Hupert retains a significant shareholding.

Valuation

Unfortunately, Pro Medicus's potential is no secret anymore.

It's now valued around $1.77 billion based on 103.3 million shares on issues. This compares to a profit of $9.08 million for the six-months ending December 31 2018 so we can see today's investors are betting it has the potential to double profits and more over the next few years.

This looks a reasonable assumption, but the stock is likely in for huge falls if the company doesn't deliver on the growth expectations.

For example rising or margin-eating competition, tech changes, and operational bloopers remain risks, alongside the existing valuation.

I'm kicking myself for not buying more Pro Medicus shares since 2017 and will wait for a better valuation than today's before making a move. As for now it looks like hype, FOMO, and momentum are driving the share price higher.

Other fast risers in the software space to watch include Nearmap Ltd (ASX: NEA) and Pushpay Holdings Ltd (ASX: PPH), although the latter is not a business I'm keen on.

Tom Richardson owns shares of Nearmap Ltd. and Pro Medicus Ltd.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia's parent company Motley Fool Holdings Inc. recommends Pro Medicus Ltd & Ramsay Healthcare. The Motley Fool Australia owns shares of and has recommended Nearmap Ltd. and Pro Medicus Ltd. The Motley Fool Australia owns shares of PUSHPAY FPO NZX. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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