2 insanely inexpensive health stocks

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After the S&P 500has grown almost 38% in the past 12 months, there aren’t many investment gurus calling the stock market cheap. There are different theories as to what drove up stock prices – low interest rates, lax monetary policy, federal stimulus efforts, peak spending among millennials, or a combination of these factors – but most experts agree that the market seems expensive. . That said, there are still some great deals on specific stocks to be had for investors willing to buy and own companies focused on slow and steady growth.

Quest Diagnosis (NYSE: DGX) and Laboratory Society of America (NYSE: LH) are two examples. Together, they dominate a vital and growing part of the healthcare system, with market shares of around 25% and 31%, respectively, in the otherwise fragmented medical diagnostics space. The pandemic shed light on this segment of the healthcare industry in 2020, and after a record year, these two companies are trading at valuations close to their all-time lows.

Image source: Getty Images.

A quick glance in the rearview mirror

To properly paint a picture of the bargains these stocks represent today, let’s start with a look back at the past two decades. The COVID-19 pandemic has resulted in increased income and profits from diagnostics that are not expected to be sustainable. Yet both companies have strong competitive positions and reasonable prospects for the future, while trading at extremely low price-to-earnings ratios.

DGX PE ratio graph

PE DGX report given by YCharts

1. Quest diagnosis

Quest operates a network with nearly 7,000 retail and patient access points. It performs 1.8 million tests per day on average and serves a third of the American adult population and about half of doctors and hospitals. Yet despite the essential role it plays in the healthcare system, its growth was until recently anemic.

In the eight years leading up to the pandemic, its annual revenue growth was less than 0.5% on average. Of course, COVID-19 testing boosted revenue by 22% in 2020. This boom continued into the first quarter of 2021: Quest Diagnostics announced that its revenue grew 49% year-over-year. the other. Management expects this coronavirus-related revenue to decline for the remainder of the year. The company estimates that it can achieve revenue growth of between 4% and 5% per year, of which about half is through acquisitions, and growth in adjusted earnings per share of between 7 and 9%.

Before the pandemic, Quest Diagnostics routinely produced about $ 0.16 in operating cash flow (CFFO) for every $ 1 in revenue. Over the years, the stock has traded between 10 and 14 times the CFFO. Today, it is trading at a ratio below 7. Even ignoring the past 18 months, its price is around 12.5 times 2019 cash flow.

Plus, at current stock prices, the stock dividend yield is 1.95% healthy. Management just increased the quarterly payment by over 10% to $ 0.62 per share. The company has also been repurchasing shares for a decade and recently added an additional $ 1 billion to its share buyback authorization. In total, the number of shares outstanding has fallen by 15% since 2012.

It might not be the most exciting action to own. But Quest Diagnostics’ combination of slow and steady growth, dividend increases, and stock buybacks make it a safe investment in a market full of expensive choices. Add to that its historically low price relative to earnings and cash flow, and it’s easy to see Quest is one of the best deals among healthcare stocks today.

2. Laboratory Society of America

Laboratory Corporation of America – more commonly known as Labcorp – handles approximately 160 million patient visits per year. He solidified the duopoly in medical testing in 2014, when he acquired Covance and its $ 2.6 billion in revenue. Added to its own $ 6 billion, this has made it the largest diagnostics company in the industry. It operates nearly 2,000 patient service centers and is networked in more than 6,000 practices and medical establishments.

Labcorp has relied on acquisitions to fuel its growth to a much greater extent than Quest. Management spent $ 267 million on strategic acquisitions last year, even during the pandemic. Between 2015 and 2019, he spent $ 9 billion on it, eclipsing the $ 1.6 billion Quest spent on acquisitions during the same period. Perhaps that is why growth has become a little easier for Labcorp. Its revenue had grown by around 3% per year before the acquisition of Covance and was around 6% per year until 2020.

The two companies had similar historical valuations. Labcorp has traded in a range of 10 and 13 times CFFO in the years prior to 2020. This makes its current ratio of 8.2 seem like a good deal. Applying its pre-pandemic cash flow generation to the equation, the stock is trading at a 16x CFFO.

Unlike Quest, Labcorp does not pay a dividend. In addition, its number of shares outstanding has remained roughly stable. In the minds of many shareholders, these relative negatives may be offset by Labcorp’s higher growth rate. Management validated this view when it raised its revenue and profit guidance in its first quarter earnings call. Although revenue growth is only expected between 2% and 6.5% this year, he now estimates that earnings per share will increase by almost 40%.

What type of health investor are you?

That a pair of companies that together control more than half of a critical portion of America’s healthcare infrastructure are trading at valuations close to all-time lows may seem absurd. Of course, a single pandemic per century can skew some measurements. Still, those stocks are trading at reasonable multiples, even relative to 2019. And there is strong evidence that suggests COVID-19 testing is going to remain a big business for the foreseeable future.

For investors who are considering opening a position in one of them, the deciding factor may depend on their personal preferences in the allocation of capital. Are you a revenue-oriented investor who prefers to collect dividends and benefit from share buybacks, or do you prefer companies that spend more of their profits on acquisitions to grow? Regardless of their choice, investors looking for cheap healthcare stocks with a history of consistency will be able to rest the night after buying Quest or Labcorp.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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