With a price-to-earnings (or "P/E") ratio of 33.4x American States Water Company (NYSE:AWR) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 19x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
American States Water 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Keen to find out how analysts think American States Water's future stacks up against the industry? In that case, our free report is a great place to start.
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like American States Water's to be considered reasonable.
Retrospectively, the last year delivered a decent 10% gain to the company's bottom line. The latest three year period has also seen a 23% overall rise in EPS, aided somewhat by its short-term performance. So we can start by confirming that the company has actually done a good job of growing earnings over that time.
Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 5.2% each year over the next three years. That's shaping up to be materially lower than the 13% per year growth forecast for the broader market.
With this information, we find it concerning that American States Water is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
What We Can Learn From American States Water's P/E?
The price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
Our examination of American States Water's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Don't forget that there may be other risks. For instance, we've identified 1 warning sign for American States Water that you should be aware of.
Of course, you might also be able to find a better stock than American States Water. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.
This article by Simply Wall St is general in nature. 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.
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