Advanced Drainage Systems, Inc.'s (NYSE:WMS) price-to-earnings (or "P/E") ratio of 25.4x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 18x and even P/E's below 10x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Advanced Drainage Systems certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

How Is Advanced Drainage Systems' Growth Trending?

There's an inherent assumption that a company should outperform the market for P/E ratios like Advanced Drainage Systems' to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 5.2%. Pleasingly, EPS has also lifted 138% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 9.9% per year as estimated by the seven analysts watching the company. That's shaping up to be similar to the 10% each year growth forecast for the broader market.

With this information, we find it interesting that Advanced Drainage Systems is trading at a high P/E compared to the market. 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 Bottom Line On Advanced Drainage Systems' P/E

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.

Our examination of Advanced Drainage Systems' analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. 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. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Plus, you should also learn about these 2 warning signs we've spotted with Advanced Drainage Systems.

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.