Some Confidence Is Lacking In Advanced Drainage Systems, Inc.'s (NYSE:WMS) P/E

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Advanced Drainage Systems, Inc. (NYSE:WMS) as a stock to potentially avoid with its 21.9x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

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.

How Is Advanced Drainage Systems' Growth Trending?

The only time you'd be truly comfortable seeing a P/E as high as Advanced Drainage Systems' is when the company's growth is on track to outshine the market.

If we review the last year of earnings growth, the company posted a worthy increase of 5.2%. The latest three year period has also seen an excellent 138% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 9.9% each year as estimated by the seven analysts watching the company. With the market predicted to deliver 10% growth each year, the company is positioned for a comparable earnings result.

In light of this, it's curious that Advanced Drainage Systems' P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price 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.

We've established that Advanced Drainage Systems currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Having said that, be aware Advanced Drainage Systems is showing 1 warning sign in our investment analysis, you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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.