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Quest Diagnostics Inc(DGX-N)

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Want Growing Passive Income? Consider Buying This Stock

Motley Fool - Wed May 24, 2023

The most reliable dividend-paying stocks all have one major trait in common: They all aim to meet the needs of the patients or customers whom they serve. As one of the largest diagnostic companies in the United States, Quest Diagnostics(NYSE: DGX) is vitally important to the healthcare sector.

Even with a major challenge to its business in the near term, the diagnostics company appears to be a buy for dividend growth investors. Here are three reasons why.

1. Quest's core business is thriving

Prior to the pandemic, Quest Diagnostics was already an impressive company, serving 1-in-3 American adults and half of the hospitals in the U.S. Thanks to its commitment to innovation, the company was able to quickly respond to the pandemic by launching five different types of COVID-19 tests. This provided a temporary boost to its growth prospects: Full-year revenue surged 14.3% in 2021 to $10.8 billion, and adjusted diluted earnings per share (EPS) soared 27.4% for the year to $14.24.

The company's revenue fell 10.7% year over year to $2.3 billion in the first quarter of 2023. Demand for its COVID-19 tests has been falling for some time. And with testing revenue plunging 80.2% over the year-ago period to $119 million, growth looks to have hit a wall -- at least for now.

But not all hope is lost. While COVID-19-testing revenue tailed off during the first quarter, the rest of the business is marching along smoothly as more patients return to the doctor for routine blood tests. Non-COVID-19 testing revenue, including blood glucose tests and complete blood count tests, rose by 10% to $2.2 billion for the quarter.

This momentum in its base testing business explains why the analyst consensus is that Quest will revert to modest 2.4% top-line growth in 2024.

The company's adjusted diluted EPS dropped by 36.6% year over year to $2.04 during the first quarter. Quest Diagnostics managed to marginally lower its operating expenses to $2 billion in the quarter. But this wasn't enough to overcome the lower revenue base.

That explains how adjusted diluted EPS declined faster than revenue for the quarter. Perhaps not surprisingly, Quest's adjusted diluted EPS will also begin to recover in 2024 as top-line growth returns and its profit margin strengthens.

A doctor and patient at an appointment.

Image source: Getty Images.

2. Quest's market-topping payout can keep climbing

Quest Diagnostics' 2.2% dividend yield makes it an enticing income stock when stacked up against the S&P 500's average 1.6% yield. Aside from providing investors with attractive starting income, the company also could be poised to extend its decade-plus streak of dividend growth in the years ahead.

This is because, for one, the dividend payout ratio is set to be around 32% in 2023. Such a manageable number allows the company to retain enough funds for business growth, share buybacks, and debt reduction. Pairing that with the annual earnings growth in the low- to mid-single-digits that I anticipate over the medium term should fuel growth in the dividend.

3. Quest Diagnostics is a deeply discounted stock

Due to the growth roadblock that the company will face in 2023, the stock price has dipped 6% in the past 12 months. As a result, Quest Diagnostics' forward price-to-earnings (P/E) ratio of 14.4 is well below the diagnostics and research industry's average forward P/E of 22.5. This is what arguably has created a buying opportunity for dividend growth investors.

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Kody Kester has no position in any of the stocks mentioned. The Motley Fool recommends Quest Diagnostics. The Motley Fool has a disclosure policy.

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