Advanced Drainage Systems, Inc.'s (NYSE:WMS) 27% Price Boost Is Out Of Tune With Earnings

Advanced Drainage Systems, Inc. (NYSE:WMS) shares have continued their recent momentum with a 27% gain in the last month alone. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 8.2% in the last twelve months.

Following the firm bounce in price, Advanced Drainage Systems may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 25.9x, since almost half of all companies in the United States have P/E ratios under 19x and even P/E's lower than 11x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

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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 recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Check out our latest analysis for Advanced Drainage Systems

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Advanced Drainage Systems.

Is There Enough Growth For Advanced Drainage Systems?

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, dishearteningly the company's profits fell to the tune of 13%. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 17% in total. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the 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 nine analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 11% each year, which is not materially different.

In light of this, it's curious that Advanced Drainage Systems' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Final Word

Advanced Drainage Systems' P/E is getting right up there since its shares have risen strongly. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

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.

A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Advanced Drainage Systems with six simple checks on some of these key factors.

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).

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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.