DexCom, Inc. (NASDAQ:DXCM) shareholders that were waiting for something to happen have been dealt a blow with a 44% share price drop in the last month. The recent drop completes a disastrous twelve months for shareholders, who are sitting on a 52% loss during that time.

In spite of the heavy fall in price, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may still consider DexCom as a stock to avoid entirely with its 38.5x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

DexCom certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as DexCom's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a terrific increase of 85%. As a result, it also grew EPS by 14% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 18% each year over the next three years. That's shaping up to be materially higher than the 10% per annum growth forecast for the broader market.

In light of this, it's understandable that DexCom's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Bottom Line On DexCom's P/E

DexCom's shares may have retreated, but its P/E is still flying high. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of DexCom's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

You always need to take note of risks, for example - DexCom has 2 warning signs we think you should be aware of.

You might be able to find a better investment than DexCom. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com