What Do The Returns On Capital At Quest Diagnostics (NYSE:DGX) Tell Us?
There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Quest Diagnostics (NYSE:DGX) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Quest Diagnostics, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.099 = US$1.1b ÷ (US$13b - US$1.8b) (Based on the trailing twelve months to June 2020).
Thus, Quest Diagnostics has an ROCE of 9.9%. On its own that's a low return on capital but it's in line with the industry's average returns of 9.8%.
Check out our latest analysis for Quest Diagnostics
In the above chart we have measured Quest Diagnostics' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Quest Diagnostics' ROCE Trending?
When we looked at the ROCE trend at Quest Diagnostics, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 9.9% from 14% five years ago. However it looks like Quest Diagnostics might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
In Conclusion...
Bringing it all together, while we're somewhat encouraged by Quest Diagnostics' reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 104% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
On a final note, we found 2 warning signs for Quest Diagnostics (1 is significant) you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
This article by Simply Wall St is general in nature. 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.
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