Unpleasant Surprises Could Be In Store For Quest Diagnostics Incorporated's (NYSE:DGX) Shares

There wouldn't be many who think Quest Diagnostics Incorporated's (NYSE:DGX) price-to-earnings (or "P/E") ratio of 17.6x is worth a mention when the median P/E in the United States is similar at about 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.

With earnings that are retreating more than the market's of late, Quest Diagnostics has been very sluggish. One possibility is that the P/E is moderate because investors think the company's earnings trend will eventually fall in line with most others in the market. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping it doesn't keep underperforming if your plan is to pick up some stock while it's not in favour.

Check out our latest analysis for Quest Diagnostics

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Quest Diagnostics.

Is There Some Growth For Quest Diagnostics?

In order to justify its P/E ratio, Quest Diagnostics would need to produce growth that's similar to the market.

Retrospectively, the last year delivered a frustrating 6.5% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 28% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 7.5% per year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 10% 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. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Key Takeaway

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Quest Diagnostics' analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the 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.

You should always think about risks. Case in point, we've spotted 1 warning sign for Quest Diagnostics you should be aware of.

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.

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

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.