Dividend stocks are everywhere, but many just downright stink. In some cases, the business model is in serious jeopardy, or the dividend itself isn't sustainable. In others, the dividend is so low, it's not even worth the paper your check is printed on. A solid dividend strikes the right balance of growth, value, and sustainability.
Today we're going to look at one dividend-paying company that you can put in your portfolio for the long term without too much concern. This isn't to say that these stocks don't share the same macro risks that other companies have, but they are a step above your common grade of dividend stock. Check out the previous selection.
This week, we'll turn our attention to molecular diagnostics and diagnostic information services provider Quest Diagnostics (DGX 3.45%) to discover why its long-term outlook and growing dividend could be an income investor's dream come true.
Obamacare: friend or foe?
As we often do when looking at potentially intriguing dividend plays, we'll start off by examining the risks associated with Quest Diagnostics. There is perhaps no greater source of uncertainty when it comes to Quest Diagnostics' business than the "Obamacare" health care reform law.
On one hand, with the individual mandate requiring citizens to purchase health insurance or face a penalty that's the greater of $95 or 1% of their annual income in 2014, it seems reasonable that increased preventive visits to the doctor may result in more diagnostic tests being ordered. While this could be true, the early reality based on proposals from the Centers for Medicare and Medicaid Services, or CMS, is that Medicare funding for diagnostic tests is going to slowly decline over the coming years. Although Quest Diagnostics derives its revenue from a number of sources, Medicare is indeed one of them. This means that Quest's bottom line could take a hit if CMS continues to scale back its Medicare reimbursements.
We've seen evidence of this in the forecasts of both Quest and its slightly larger rival by market value Laboratory Corp. of America (NYSE: LH). Quest was forced to drop its full-year earnings forecast in October due to Medicare cuts, while Laboratory Corp. of America similarly trimmed its guidance in December.
Competition is another concern for Quest, with some of its peers buying their way to growth in what has been a slow-growth industry since the recession.
Agilent Technologies (A 0.63%), for instance, purchased Danish cancer diagnostics company Dako in 2012 for a whopping $2.2 billion in an effort to grow its life sciences business. The deal made further sense given that Dako's product line complemented Agilent's existing product portfolio.
Myriad Genetics (MYGN 0.38%), while relying on its deep diagnostic pipeline, has also turned to acquisitions to drive top and bottom-line growth. Myriad announced last month the $270 million purchase of privately held Crescendo Biosciences in order to get hold of the company's rheumatoid arthritis test.
Ultimately, increased competition for similar disease diagnostic tests could drive down prices and hurt Quest's margins.
The promise of Quest Diagnostics
Still, there are a number of long-term positives that should fuel Quest Diagnostics higher.
First, the baby boomer population is starting to retire, meaning that an increase in diagnostic tests and medical care is likely around the corner. With life expectancies on the rise in the U.S. and one of the biggest cancer risk factors being old age, there's a good chance that diagnostic tests will play a crucial role in personalizing cancer treatments in the coming decade.
Second, despite worries that CMS will continue to decrease Medicare reimbursement rates, I would remind investors that Quest still receives a sizable portion of its revenue from insurers and individual payers. While that does leave it exposed to further reimbursement cuts from its Medicare business it also gives the company an opportunity to more than make up the difference in volume if more newly insured people get preventive-care checkups.
Third, consolidation within the sector only reinforces the notion that diagnostic tests may be about to become the next big thing in personalized medicine. In early February Thermo Fisher Scientific (TMO 0.55%) completed its mammoth $13.6 billion acquisition of Life Technologies in order to acquire its genome analysis line of products. Big deals like this signal the willingness of larger companies to take on risks, and also that there may be a lot of upside potential yet to come within the sector.
Finally, Quest has also been delivered a key win in recent months thanks to a June 2013 ruling by the U.S. Supreme Court that allowed it to introduce a competing BRCA 1/BRCA 2 gene test to Myriad Genetics' BRACAnalysis diagnostic test.
Show me the money!
The true allure of Quest Diagnostics could be its consistent cash flow potential and growing dividend. The chart below shows that Quest doesn't have any consistent rhyme or reason regarding when it raises its dividend, but it has nonetheless boosted its payout by a substantial 340% since 2004.
Quest today yields 2.5%, which should begin to put it on an income investor's radar. Furthermore, I consider its dividend incredibly secure given that its payout ratio only equates to about 33% of its projected fiscal 2014 earnings per share. This leaves plenty of opportunity for this dividend to grow, as well as the ability for Quest to use its cash flow to pay down its existing debt balance of $3.37 billion. It could also use its cash flow to look for additional earnings-accretive acquisitions.
At less than 13 times forward earnings, with an impressive track record of dividend growth, and holding a bright future, Quest looks like a dividend stock you can buy right now.