QUEST DIAGNOSTICS INC.

Expanding assets with this financing mix has decreased the company's reliance on debt, from $259 of assets for every $100 of equity in 1996 to about $180 in 2003 (Chart 2).

Operating Fundamentals

Chart 3 illustrates that Quest's efficiency in generating revenues from its assets has gradually declined modestly from $116 of revenues for every $100 of assets in 1996 to $110 in 2003. The 1999 decline in asset efficiency is typical following a significant acquisition such as that of SmithKlinc Beecham Clinical Labs, which doubled assets.

Projected Revenue Growth

Quest's long history of successfully growing revenues; the constant growth in an aging population; and, the company's strong financial condition suggest a considerable capacity to continue growing revenues in the future.

Accordingly, an illustrative A judgment was made to project future revenue growth of about 10% per year to approximately $7.6 billion in 2008.

Capacity to Grow EPS

Historical EPS Growth

As indicated by the Stock Study Guide's EPS profile, earnings (before discontinued, extraordinary, and special items) have grown at average rate of about 59% since 1997. However, in 2003, EPS growth slowed to a more moderate 29%.

Operating Fundamentals

Throughout the study period, growth in EPS has significantly outpaced revenues. This situation is largely the result of the company's increasing efficiency in converting revenues into earnings. Chart 4 shows that earnings from every $100 of revenues increased from $1.14 in 1997 into $9.19 in 2003.

This improvement is attributed principally to:

(1) increased economies of scale due to acquisitions;

(2) reduced interest expense related to a lower level of debt;

(3)the implementation of a "Six Sigma" initiative for improving the control over operations; and,

(4) growth in the higher-margin esoteric testing business.

Projected EPS Growth

The projected growth in Quest's revenue and further increases in its efficiency in converting revenues to earnings suggest that future RPS growth can continue to outpace revenues. Here, an illustrative A judgment was made to grow EPS at an average rate of 18% to $9.40 in 2008.

Is the Stock "On Sale" or "Over-Printed?

Chart 5 illustrates the historical relationship between growth in Quest's earnings and its high and low share prices from 1996 to 2003. The recent price of $83.00 is below the projected KPS Profile for the next five years, which suggests the stock is currently! "on sale" in relation to projected EPS growth.

Section 2 of the Stock Study Guide (pg. 41) shows a Relative Price/Earnings Ratio of 0.86. This value indicates that the recent price for $1 of Quest's EPS (about $17) is some 14% lower than the average price paid historically (about $20). Again, this suggests that the stock is currently "on sale".

The Canadian Comparable: MDS Inc.

The Business. MDS is a Canadian 'comparable' to the laboratory-testing segment of Quest Diagnostics Inc.

In its life sciences business (63% of the revenue), MDS provides products and services to biotechnology and pharmaceutical companies for the development of drugs and the management of disease. Products include: highly sensitive analytical instruments, medical isotopes and gamma-sterilization technology.