Despite pockets of softness, in late 2011 and early 2012 the U.S. economy remained in growth mode. Predictions of doom and gloom turned out to confirm the old joke, "The stock market has predicted nine out of the past four recessions." In our Investment Comments for February 2012, we pointed out how the widely-anticipated double dip recession of 2011 failed to materialize. The stock market was starting to shake its second-half losses. That building momentum would carry over into 2012, a year in which the S&P 500 scored total returns of 16%.
Here’s one stock that did even better. Each month, we pick three stocks to highlight for readers. Two of the stocks we highlighted in February 2012 were new additions to the newsletter. One of those was Medidata Solutions (Ticker: MDSO). Medidata primarily makes software to help pharmaceutical companies design and operate drug trials. Biotech firms and medical device makers are also clients. We modeled 15% future sales growth, lower than the company’s goal of growing 20% annually.
We had to break with tradition a little bit to add Medidata to the Investor Advisory Service. We normally like to see at least five years of operating history as a public company, but this company had only been public for two. We made an exception because we liked the opportunity. That would turn out to be a good decision.
Shares traded at $20.16 when we introduced MDSO into the IAS in the February 2012 issue. The company’s first quarterly earnings report looked a little soft on the surface, with sales coming in flat year-over-year, but the report also showed signs of a strong foundation for future improvement. Despite those flat sales, EPS increased 45%. Maybe more importantly, new client signings were accelerating. Management raised 2012 sales guidance, but also warned that full-year earnings would be impacted by a higher tax rate. Investors seemed to cheer the company’s accelerating growth, sending shares higher.
It didn’t take long for those positive signs to translate into good results. Sales increased 24% the following quarter. Pre-tax income increased 74%, although EPS growth was subdued, as anticipated. Backlog increased, suggesting difficulty keeping up with strong demand. Shares continued to rise, crossing $30 for the first time in June 2012. To keep up with demand, the company started spending heavily on R&D. That spending would have a further negative impact on earnings. When the next earnings report showed a slowdown in year-over-year sales growth, investors might have cause for concern. Worries were overshadowed, however, by a new $100 million contract representing a big competitive win.
Shares crossed $35 in July and $40 in September. At a recent price of $42.11, MDSO shares have gained 109% during the past year, far ahead of the overall market’s 16% increase. Based on estimated full-year EPS of $0.96, the stock’s P/E has now inflated to 44, making Medidata Solutions one of the priciest stocks in the IAS based on pure valuation. We don’t normally go hunting after high-flyers, but we’re not unhappy when our picks later turn into them.
Disclaimer: This company was selected for review in part because of its performance over the past year. Any outperformance relative to the broader market is not necessarily indicative of performance of the broader Investor Advisory Service.