Dear Mr. Berko: 

In December 2012, my business partner emailed you for a recommendation of three stocks that could rise by 50 percent in the next two years. You emailed him six hospital stocks and told him to take his pick. Apparently, you think the hospital industry is attractive. But if health care costs are falling, why would you recommend hospital stocks? 

H.D., Indianapolis



Dear H.D.: 

There are, at last count, 6,121 hospitals in the United States. Some focus on a broad spectrum of medical procedures, from emergency care and surgery to diagnostic care, whereas others focus on a single specialty, such as cardiology or cancer care. These hospitals get about 94 percent of their revenues from various government programs. And any time a government is involved in supporting a business, that business usually produces enormous returns for its investors.

Hospitals have traditionally been impressive profit-makers, though they keep two sets of records. 1) When a hospital bills you $1,000 a stitch to close a cut finger or $371,000 to remove a wart from your tonsils, those numbers go in one set of records, where the appropriate losses are recorded, because most of those amounts are not collectible. But great Zeus, those records produce Olympian losses. 2) The second set of records includes the actual money received for these procedures and details the real cash flow and the related net income.

This is a very competitive business, even though most hospitals are virtual monopolies in their communities. Meanwhile, hosts of new income challenges have emerged during the past decade. One of today’s most serious problems concerns the 48 million uninsured Americans (pre-Obamacare). Historically, hospitals collect about 10 percent of the amounts billed to these folks. And because hospitals are required, by law, to provide emergency care to every patient, bad-debt expenses are creating new problems in this industry.

There are many ways to cook a goat, and some hospitals’ CEOs keep coming up with new ways to skin a cat. Rich Umbdenstock, president of the American Hospital Association, announced that it’s now cricket for hospitals to pay a patient’s insurance premiums. Well, Rich, I’m going to tell you a little secret: Hospitals have been doing that for years. I personally know of an instance in which a reader’s health issues cost him a job he had for a dozen years. The reader had a serious back problem, which required a complicated lumbar fusion followed by extensive rehabilitation. Even though he was unemployed, his income for the three months he worked in 2012 plus his severance check prevented him from qualifying for government assistance. He had zero credit; he couldn’t borrow a pfennig, even though his health depended on it; and his bank account was as empty as Old Mother Hubbard’s cupboard. Well, the hospital paid his insurance premiums under COBRA for a couple of months and made out like a bandit. Though that is the only instance with which I am personally familiar, I have anecdotal evidence that it is not an uncommon occurrence. And that’s good.

This practice has yet to evolve into a large-scale trend by hospitals, which are desperately seeking innovative ways to skin a tabby and increase revenues and profits. And because revenues and profits determine bonuses and stock options, many CEOs and their executives would, in a Sioux City second, lie, cheat, steal and sell their daughters into slavery to put profits in their pockets.

Now comes a new way to skin a cat. Today, courtesy of Obamacare, people with pre-existing conditions – who, in the past, might have been denied health insurance – can no longer be denied coverage. So a growing number of hospital executives will morph into ambulance chasers, employing “health scouts” on commission. These scouts will comb the great unwashed for patients who need extensive medical or rehab treatment. After they’re signed up and the hospital fronts the insurance premiums, the scouts earn a series of sweet bonuses. That’s why I believe that companies such as Community Health Systems Inc. (CYH-$40.65), Universal Health Services Inc. (UHS-$80.87), Select Medical Holdings Corp. (SEM-$10.93), Tenet Healthcare Corp. (THC-$45.79), LifePoint Hospitals Inc. (LPNT-$52.79) and HCA Holdings Inc. (HCA-$48.96) will have significant long-term capital growth potential.