It's not a stretch to say that Quest Diagnostics Incorporated's (NYSE:DGX) price-to-earnings (or "P/E") ratio of 20.2x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 18x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.
Quest Diagnostics certainly has been doing a good job lately as it's been growing earnings more than most other companies. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.
Does Growth Match The P/E?
In order to justify its P/E ratio, Quest Diagnostics would need to produce growth that's similar to the market.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 11% last year. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 56% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 13% per annum over the next three years. That's shaping up to be materially higher than the 11% per annum growth forecast for the broader market.
In light of this, it's curious that Quest Diagnostics' P/E sits in line with the majority of other companies. It may be that most investors aren't convinced the company can achieve future growth expectations.
The Key Takeaway
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We've established that Quest Diagnostics currently trades on a lower than expected P/E since its forecast growth is higher than the wider market. There could be some unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see some volatility.
And what about other risks? Every company has them, and we've spotted 1 warning sign for Quest Diagnostics you should know about.
If these risks are making you reconsider your opinion on Quest Diagnostics, 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.
