When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") above 17x, you may consider Medifast, Inc. (NYSE:MED) as a highly attractive investment with its 4.6x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

Recent times haven't been advantageous for Medifast as its earnings have been falling quicker than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

What Are Growth Metrics Telling Us About The Low P/E?

In order to justify its P/E ratio, Medifast would need to produce anemic growth that's substantially trailing the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 17%. Even so, admirably EPS has lifted 38% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Shifting to the future, estimates from the dual analysts covering the company suggest earnings growth is heading into negative territory, declining 44% over the next year. Meanwhile, the broader market is forecast to expand by 13%, which paints a poor picture.

With this information, we are not surprised that Medifast is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Key Takeaway

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.

We've established that Medifast maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Medifast that you should be aware of.

If these risks are making you reconsider your opinion on Medifast, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.