Earnings Not Telling The Story For Advanced Drainage Systems, Inc. (NYSE:WMS) After Shares Rise 26%

Despite an already strong run, Advanced Drainage Systems, Inc. (NYSE:WMS) shares have been powering on, with a gain of 26% in the last thirty days. The last 30 days bring the annual gain to a very sharp 79%.

After such a large jump in price, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Advanced Drainage Systems as a stock to avoid entirely with its 25.4x 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 lofty.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Advanced Drainage Systems has been doing quite well of late. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Advanced Drainage Systems

Want the full picture on analyst estimates for the company? Then our free report on Advanced Drainage Systems will help you uncover what's on the horizon.

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

In order to justify its P/E ratio, Advanced Drainage Systems would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings growth, the company posted a worthy increase of 10%. This was backed up an excellent period prior to see EPS up by 165% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 7.2% during the coming year according to the eight analysts following the company. Meanwhile, the rest of the market is forecast to expand by 13%, which is noticeably more attractive.

With this information, we find it concerning that Advanced Drainage Systems is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

Advanced Drainage Systems' P/E is flying high just like its stock has during the last month. 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 Advanced Drainage Systems' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near 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 high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - Advanced Drainage Systems has 2 warning signs we think you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.