It's not a stretch to say that Advanced Drainage Systems, Inc.'s (NYSE:WMS) price-to-earnings (or "P/E") ratio of 18.1x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 18x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

With earnings growth that's superior to most other companies of late, Advanced Drainage Systems has been doing relatively well. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

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.

Is There Some Growth For Advanced Drainage Systems?

Advanced Drainage Systems' P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.

Retrospectively, the last year delivered a decent 6.3% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 139% in total over the last three years. 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 7.3% each year as estimated by the seven analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 11% each year, which is noticeably more attractive.

With this information, we find it interesting that Advanced Drainage Systems is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Advanced Drainage Systems currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 1 warning sign for Advanced Drainage Systems you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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.