American Water Works Company, Inc.'s (NYSE:AWK) Price Is Out Of Tune With Earnings

With a price-to-earnings (or "P/E") ratio of 26.1x American Water Works Company, Inc. (NYSE:AWK) 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 17x and even P/E's lower than 10x are not unusual. 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.

American Water Works Company certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for American Water Works Company

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Does Growth Match The High P/E?

American Water Works Company's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a decent 10% gain to the company's bottom line. Still, lamentably EPS has fallen 22% in aggregate from three years ago, which is disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 6.4% per annum during the coming three years according to the eleven analysts following the company. With the market predicted to deliver 11% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that American Water Works Company's P/E sits above the majority of other companies. 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.

The Bottom Line On American Water Works Company's P/E

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 American Water Works Company currently trades on a much 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 high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 2 warning signs for American Water Works Company you should be aware of, and 1 of them shouldn't be ignored.

If you're unsure about the strength of American Water Works Company'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.