Advanced Drainage Systems, Inc.'s (NYSE:WMS) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Advanced Drainage Systems (NYSE:WMS) has had a rough month with its share price down 3.9%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Advanced Drainage Systems' ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Advanced Drainage Systems is:

29% = US$453m ÷ US$1.5b (Based on the trailing twelve months to March 2025).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.29.

View our latest analysis for Advanced Drainage Systems

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Advanced Drainage Systems' Earnings Growth And 29% ROE

To begin with, Advanced Drainage Systems has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 13% also doesn't go unnoticed by us. Under the circumstances, Advanced Drainage Systems' considerable five year net income growth of 32% was to be expected.

As a next step, we compared Advanced Drainage Systems' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 15%.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Advanced Drainage Systems fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Advanced Drainage Systems Efficiently Re-investing Its Profits?

Advanced Drainage Systems' ' three-year median payout ratio is on the lower side at 8.7% implying that it is retaining a higher percentage (91%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, Advanced Drainage Systems is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 10%. However, Advanced Drainage Systems' future ROE is expected to decline to 20% despite there being not much change anticipated in the company's payout ratio.

Conclusion

Overall, we are quite pleased with Advanced Drainage Systems' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.