With a median price-to-earnings (or "P/E") ratio of close to 18x in the United States, you could be forgiven for feeling indifferent about Diamondback Energy, Inc.'s (NASDAQ:FANG) P/E ratio of 17x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Diamondback Energy 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 might be that many expect the strong earnings performance to deteriorate like the rest, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

Is There Some Growth For Diamondback Energy?

There's an inherent assumption that a company should be matching the market for P/E ratios like Diamondback Energy's to be considered reasonable.

Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. Likewise, not much has changed from three years ago as earnings have been stuck during that whole time. Therefore, it's fair to say that earnings growth has definitely eluded the company recently.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 2.2% per year as estimated by the analysts watching the company. Meanwhile, the broader market is forecast to expand by 10% per year, which paints a poor picture.

In light of this, it's somewhat alarming that Diamondback Energy's P/E sits in line with the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

The Final Word

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Diamondback Energy's analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its P/E as much as we would have predicted. When we see a poor outlook with earnings heading backwards, we suspect share price is at risk of declining, sending the moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

It is also worth noting that we have found 3 warning signs for Diamondback Energy (1 doesn't sit too well with us!) that you need to take into consideration.

You might be able to find a better investment than Diamondback Energy. 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.