It is not clear to me what that does, but it looks like it displays
the diagnostic on a different screen line, not on the line to which
the diagnostic belongs?

Yes exactly. It shows diagnostics on different screen lines, based on where space is available.

That is strange to hear, because it doesn't allow to have an overview
of the diagnostics at a glance.

Yeah I'm not advocating for this behavior to be included in emacs, just sharing my experience.