What Watt's S.A.'s (SNSE:WATTS) 26% Share Price Gain Is Not Telling You

Watt's S.A. (SNSE:WATTS) shares have continued their recent momentum with a 26% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 31%.

After such a large jump in price, Watt's' price-to-earnings (or "P/E") ratio of 14.6x might make it look like a strong sell right now compared to the market in Chile, where around half of the companies have P/E ratios below 8x and even P/E's below 5x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

The earnings growth achieved at Watt's over the last year would be more than acceptable for most companies. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

Check out our latest analysis for Watt's

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Watt's' earnings, revenue and cash flow.

Is There Enough Growth For Watt's?

In order to justify its P/E ratio, Watt's would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 21%. However, this wasn't enough as the latest three year period has seen a very unpleasant 31% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 24% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Watt's is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

The strong share price surge has got Watt's' P/E rushing to great heights as well. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Watt's currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place 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 2 warning signs for Watt's (1 makes us a bit uncomfortable) you should be aware of.

If you're unsure about the strength of Watt's' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.