Quest Diagnostics Incorporated (NYSE:DGX) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?
It is hard to get excited after looking at Quest Diagnostics' (NYSE:DGX) recent performance, when its stock has declined 7.3% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Quest Diagnostics' ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for Quest Diagnostics
How Is ROE Calculated?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Quest Diagnostics is:
30% = US$2.0b ÷ US$6.5b (Based on the trailing twelve months to March 2022).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.30 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Quest Diagnostics' Earnings Growth And 30% ROE
To begin with, Quest Diagnostics has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 16% also doesn't go unnoticed by us. As a result, Quest Diagnostics' exceptional 26% net income growth seen over the past five years, doesn't come as a surprise.
We then compared Quest Diagnostics' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 18% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Quest Diagnostics is trading on a high P/E or a low P/E, relative to its industry.
Is Quest Diagnostics Efficiently Re-investing Its Profits?
Quest Diagnostics' three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. By the looks of it, the dividend is well covered and Quest Diagnostics is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.
Moreover, Quest Diagnostics is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 28% of its profits over the next three years. However, Quest Diagnostics' future ROE is expected to decline to 15% despite there being not much change anticipated in the company's payout ratio.
Summary
Overall, we are quite pleased with Quest Diagnostics' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
