Medical Lab Test Stocks Poised for Big Payday

Quest Diagnostics (NYSE: DGX ) and Laboratory Corp. of America (NYSE: LH ) may be the Goliaths of the U.S. market for clinical laboratory testing, but the David of the industry, Bio-Reference Laboratories (NASDAQ: BRLI ), has been a giant in the eyes of investors  In the past two years, Bio-Reference is up about 120% to $22.54. During the same period, Quest has been the poorest performer of the three, gaining only 20%, while LabCorp shares have climbed 60%. The picture is changing, though. So far in 2011, shares of all three companies are up, but Quest has the biggest gain and Bio-Reference the smallest.  Some suggest this is just a short-term aberration while others insist it's a sign of things to come. Quest is the biggest independent research and testing laboratory in the world, holding about a 15% share of the more-than-$50 billion U.S. market. The company has been driving industry consolidation recently by buying up some of its smaller competitors. In February, Quest acquired privately held Athena Diagnostics for $740 million, boosting its share in the large market for neurology testing, where its main competitor is LabCorp.  Last week, Quest moved to buy Celera (NASDAQ: CRA ) for $671 million. This buyout would enable Quest to get its hands on Celera's proprietary genetic tests and access to proprietary genetic tests used by clients UnitedHealth (NYSE: UNH ) and Aetna (NYSE: AET ), as well as a valuable diagnostic pipeline. Stealing UnitedHealth's business away from Quest has enabled LabCorp to grow faster than its main competitor. In fact, LabCorp’s three-year average return on equity of 26.5% easily tops that of Bio-Reference Labs (18.4%) and Quest (19.3%). During the past five years, LabCorp also has enjoyed a nice 14% gain in earnings per share, outpacing Quest, but far behind the more than 25% gain turned in by Bio-Reference. That trend is expected to continue during the next five years, with Bio-Reference again maintaining its lead, although its growth rate is expected to slow somewhat. The rosy outlook for all three companies is likely to come from a number of factors. First, hospital laboratories will continue to move in-house testing to commercial labs. In addition, the focus of healthcare is moving from treating sick patients to wellness, prevention and early detection of disease. The growing and aging population also will increase the number of tests performed for each patient. Then there's the advent of personalized medicine and targeted diagnostic tests, which is already helping doctors make more informed therapy decisions and monitor the effectiveness of treatment. However, the industry is facing some bumps in the road. Foremost among them is political pressure to lower health care costs and budget cuts to Medicare or Medicaid. Still, all three companies appear to be good bets for investors. Lately, Bio-Reference may be feeling the effects of selling at a premium to its two main competitors, with a P/E of more than 21 vs. 17 for LabCorp and 14 for Quest.  Those who don't want to pick among the three might want to consider the iShares Dow Jones US Healthcare Provider (NYSE: IHF ) exchange-traded fund. Quest and LabCorp are among its top 10 holdings.
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