The health-care sector has lots of room to grow because of increasing demand from aging baby boomers, among other factors, says advisor Ramesh Gulati. He tells MoneyShow.com about some smaller stocks that are not household names.

Kate Stalter: I’m speaking with Ramesh Gulati of Gulati Asset Management. Ramesh, welcome to Daily Guru. I understand that you have some thoughts today on some health-care sector names to discuss.

Ramesh Gulati: Just before I start, a quick disclosure. Gulati Asset Management and its clients may be long or short in any of the names that are talked about in this article. Please don’t make any decisions solely on this article. Please consult your financial advisory before you do anything like that.

Yes, I did look into the health-care area. I find it really, again, comes back to demographics, where we have an aging population in this country. As you know, the 76 million baby boomers have really shaped the business universe over their lifetime.

It’s like, if you want to see a hamster that’s eaten by a snake. Where this bulge is moving through, it really affects everything. Everything from baby furniture when they were first born, to car sales when they became of age. Now it’s going to be affecting the health-care industry, because the baby boomers are starting to retire, and they don’t want to look or feel old.

So, as they’ve known throughout their lifetimes, they will be doing anything and everything they can to both look and feel young. So, health care is an area that I see in the years to come will be doing very well.

One in particular…that might be a little preemptive, but I find it’s a very undervalued stock, and it’s in the area of nursing skilled care: It’s a company by the name of Five Star (FVE), and they own and operate senior living facilities. They have about 245 communities throughout the country.

I found this company a while back, and I actually can’t believe that it’s trading so cheaply. It’s got a P/E right now of 2.22. So, it’s only trading at really two times their earnings right now, and they have amazing free cash flow.

And also, if you look at it from a book-value standpoint, they’re actually trading at 50% of their book value right now. So if you were to liquidate their assets, it’s actually double what they’re trading for right now.

They just recently got a new $150 million line of credit, and that line of credit, the interest rate they’re paying is about 300 basis points less than some of their top competitors. So, it really shows the financial stability of this company.

Kate Stalter: Yeah, that’s an interesting one. Any other names from that sector, or are there other areas of health care that you’ve been looking at?

Ramesh Gulati: Sure, well that sector, and particularly the nursing home sector. Another one is Advocat (AVCA). So, the two that I like in that area is Advocat, but most primarily is Five Star.

Another area that I took a look at, which I think is very interesting, is the small-cap medical device area. So, this is an area where usually these companies are less than $100 million in market cap, and they have different kinds of devices or techniques that they use to sell into the healthcare market, which they can do very well with.

The first one I look at in that area is a company by the name of Fonar (FONR). They also have a very low P/E of about 5.4. What they do is they’re in the specialty MRI equipment market, and equipment centers.

They have MRIs that are very specific. Usually, as you know, in the old days you’d go into an MRI, and you’d think that you were in a coffin. You couldn’t move, you couldn’t do anything.

This company has an MRI where you can stand, you can sit, you can move to the position that hurt. You know, you say, “Oh, it hurts when I do this.” The good doctor would just say, “Well then don’t do that.” In this way, you can go into that position where it hurts, and they can take a look with the MRI and see exactly what’s happening in that.

So, it’s an interesting company. It’s moved up very rapidly. In the beginning of the year it was trading about $1.80, and now it’s somewhere about $4. It’s something that I wouldn’t go and jump into.

Please remember a lot of these companies are very thinly traded. It doesn’t take a lot of volume to move these up or down. So, if it’s something that you would be interested in, I would suggest buying in maybe 25% of your position at a time when you go into something like that.

A few other ones that I found very interesting: A company by the name of Alpha Pro Tech (APT). They do disposable and protective apparel. So, anything when it comes to in the disease area or any type of contaminant both in healthcare and also industrial.

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What I like in this area is stuff that people have to buy and throw away, and then have to buy again. That’s what this company does. They’re trading at a P/E of about 32, but a forward P/E of only about 11, and they’ve moved up from about $1 to $1.50. So, it’s definitely one of those small caps that you could see some good growth with.

Another one in this area is Cryolife (CRY). What they do is they preserve and distribute human tissue for transplantation, and also devices for cardiac and vascular applications. So, they’ll actually make different arteries and veins for when surgeons need to go and replace these throughout your body.

It’s very technical, but they also have done very well. They have a very reasonable P/E of about 19.75 right now. They’ve recently moved from $4.20 up to about $6, but they’re back to around $5. For your more speculative-type investments, this could be something that’s interesting.

Another company that I like a lot is a medial diagnostic and imaging system company by the name of Digirad (DRAD). They have a lot of cash on the balance sheet. They just had to recently change their CFO, but it looks like they’re getting back on track to profitability.

Going back, again looking at baby boomers wanting to stay young. No one will ever admit it, but a lot of these people have actually gone to plastic surgeons. You find that went the economy recovers, which it has, at least it’s on the way to recovery, those treatments skyrocket.

There’s a company by the name of Cynosure (CYNO) that does aesthetic treatment systems, and they use lasers and light for plastic surgeons for wrinkle removal and a number of different procedures that plastic surgeons do.

One that I found very interesting is a company by the name of Given Imaging (GIVN). They do visualization and detection of the gastrointestinal tract disorders. In a simple way, they put a camera in a pill, you swallow the pill, and it tracks it through your whole system. It’s really amazing.

They’re out of Israel. They have a high P/E of 51, but it shows the growth that they’re on. They’ve been kind of fluctuating between $14 and $20. They’re closer to $20 right now, but it’s a very interesting type of system.

Another company that I think you had mentioned in one of your articles is Synergetics (SURG), that does surgical devices and kits for ophthalmology and neurosurgery. They popped up on my radar.

The other reason why I like this is that again it’s something that you sell, the surgeon uses it, and then has to discard it, and then buy it again. So, that’s an area that I really like, those disposable-type areas.

A company by the name of Masimo (MASI). They do patient monitoring. Another similar-type company is CardioNet (BEAT). They do outpatient management and monitoring.

So, these are just a quick synopsis of some of the small-cap device companies that I like, and the one that I mentioned in the nursing home facility, which is Five Star, which I think is grossly undervalued right now.

Kate Stalter: Let me ask you this, Ramesh. That’s just a terrific collection of some ideas there for folks, but how would you suggest people incorporate some of these smaller cap, thinly traded, more speculative names within an overall investment portfolio?

Ramesh Gulati: They should definitely be in the more speculative camp, so I would not suggest putting a ton of money into any one of these companies, as I would any type of company.

You should be well diversified. But I like to buy these types in a basket where you’re never going to know which one is going to hit. You put together your own little mutual fund, if you will.

You say, “OK, maybe I have $10,000 or $15,000 that I want to allocate to this area,” and then buy a basket of them. Maybe a few thousand dollars into each one, and then you basically, obviously monitor it, but you pretty much tuck it away.

Hopefully these technologies catch on, and then all of a sudden, you might have one or two in your portfolio that is up ten times from what you bought it.

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