Quest Diagnostics Incorporated's (NYSE:DGX) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?
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Quest Diagnostics' (NYSE:DGX) stock is up by a considerable 5.0% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Quest Diagnostics
How To Calculate Return On Equity?
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:
13% = US$890m ÷ US$6.9b (Based on the trailing twelve months to September 2024).
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 $0.13 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
A Side By Side comparison of Quest Diagnostics' Earnings Growth And 13% ROE
At first glance, Quest Diagnostics seems to have a decent ROE. Even when compared to the industry average of 13% the company's ROE looks quite decent. However, while Quest Diagnostics has a pretty respectable ROE, its five year net income decline rate was 5.7% . So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
So, as a next step, we compared Quest Diagnostics' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 5.4% over the last few years.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Quest Diagnostics fairly valued compared to other companies? These 3 valuation measures might help you decide.