Advanced Drainage Systems, Inc.'s (NYSE:WMS) Shares May Have Run Too Fast Too Soon

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 Advanced Drainage Systems, Inc.'s (NYSE:WMS) P/E ratio of 18.2x. 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.

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Advanced Drainage Systems could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to strengthen positively, which has kept the P/E from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

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Is There Some Growth For Advanced Drainage Systems?

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 4.9%. Even so, admirably EPS has lifted 108% in aggregate from three years ago, notwithstanding the last 12 months. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 3.0% over the next year. With the market predicted to deliver 14% growth , the company is positioned for a weaker earnings result.

In light of this, it's curious that Advanced Drainage Systems' P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Advanced Drainage Systems' P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

Our examination of Advanced Drainage Systems' 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. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Advanced Drainage Systems that you need to be mindful of.

Of course, you might also be able to find a better stock than Advanced Drainage Systems. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.