Better Buy: Laboratory Corp Vs. Quest Diagnostics

LabCorp (LH) and Quest Diagnostics (DGX) face off in the competitive lab services market. Since warmer weather boosts lab services volume, let's see if one is a better buy than the other.

Apr 3, 2014 at 10:58PM

Lab services may not be the first investment idea you consider when thinking about warm weather plays, but maybe it should be. Major lab services plays Laboratory Corp (NYSE:LH) and Quest Diagnostics (NYSE:DGX) both remind investors in their annual reports that testing volume tends to slide through the holidays and pick up in spring. Given that backdrop, is one of these two lab giants a better buy?

LH Chart

LH data by YCharts

Debating sales
While spending on lab tests on fluids like blood or tissues makes up just 3% of total health-care spending, lab results influence 60% to 70% of all physician decisions. That means lab testing is, and is likely to remain, a major driver behind how primary-care doctors and specialists decide to treat -- and prevent -- a variety of diseases, including heart disease and cancer.

Since 8,000 baby boomers are turning 65 every day,  and chronic illness is more common among older people, it stands to reason that Lab Corp and Quest's sales will both track higher over the long haul. Given that both companies are mature and have widespread client footprints, let's see how investors are currently valuing them relative to sales.

Of the two, Lab Corp is the most expensive in terms of the price investors are willing to pay for every dollar of revenue. Investors are currently paying 1.6 times sales for shares, while they're paying just 1.3 times revenue for shares in Quest.

However, that's not shocking given investors have traditionally awarded Lab Corp a premium valuation. It should also be noted that the ratio is relatively low on both compared to where it's been in the past.

LH PS Ratio (TTM) Chart

LH PS Ratio (TTM) data by YCharts

Debating earnings
Lab Corp's better margin is likely one reason investors have been willing to pay more for its shares than Quest's. Lab Corp's operating margin is 17.4%, while Quest's is 16.8%. That suggests Lab Corp is better positioned to drop more of the jump in seasonal volume to its bottom line.

As you'd expect, that profit-friendly advantage has investors paying more for Lab Corp's earnings than for Quest's. Lab Corp is trading at 14.4 times future earnings, which is slightly higher than Quest's 14 P/E ratio. Investors should also know that trailing 12-month P/E ratios aren't overly pricey at either company.

LH PE Ratio (TTM) Chart

LH P/E Ratio (TTM) data by YCharts

However, P/E ratios only tell a little bit of the story. Analysts have cut their estimates for Lab Corp's 2015 earnings from $7.2 to $7.1 per share during the past 90 days, and while that's not a good thing, the drop is far less than the the $4.60 to $4.32 cut to Quest's expected earnings.

Fool-worthy final thoughts
In the debate over which is a better buy, these two appear pretty equally matched; however, Quest may have an edge given its shares cheaper to sales, and it has a slightly lower forward P/E ratio.

That may mean Quest is a better bet for value investors than Lab Corp, especially considering that, while Lab Corp doesn't pay a dividend, Quest does. Granted, Quest's forward dividend yield isn't as high as the big pharmaceutical companies, but at 2.2%, it's still healthy.

Investors should also know that short sellers have amassed an arguably aggressive short position in Quest that totals 13 days worth of average daily trading volume. Given Quest's valuation, any good news could mean that Quest's shares head higher more quickly than Lab Corp as short sellers cover. 

Lab services may be a good long-term bet, but Buffett would like these more
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