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Will Weakness in Quest Diagnostics Incorporated's (NYSE:DGX) Stock Prove Temporary Given Strong Fundamentals?

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With its stock down 9.9% over the past month, it is easy to disregard Quest Diagnostics (NYSE:DGX). 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. In this article, we decided to focus on Quest Diagnostics' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Quest Diagnostics is:

35% = US$2.3b ÷ US$6.5b (Based on the trailing twelve months to September 2021).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.35 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Quest Diagnostics' Earnings Growth And 35% ROE

First thing first, we like that Quest Diagnostics has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 17% also doesn't go unnoticed by us. So, the substantial 24% net income growth seen by Quest Diagnostics over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Quest Diagnostics' growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. 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. What is DGX worth today? The intrinsic value infographic in our free research report helps visualize whether DGX is currently mispriced by the market.

Is Quest Diagnostics Efficiently Re-investing Its Profits?

The three-year median payout ratio for Quest Diagnostics is 34%, which is moderately low. The company is retaining the remaining 66%. So it seems that Quest Diagnostics is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Additionally, Quest Diagnostics has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 28%. Regardless, Quest Diagnostics' ROE is speculated to decline to 16% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with Quest Diagnostics' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.