American States Water Company's (NYSE:AWR) Shares May Have Run Too Fast Too Soon

American States Water Company's (NYSE:AWR) price-to-earnings (or "P/E") ratio of 23.4x 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 16x and even P/E's below 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times have been pleasing for American States Water as its earnings have risen in spite of the market's earnings going into reverse. 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.

View our latest analysis for American States Water

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Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as American States Water's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered an exceptional 54% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 48% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 1.1% each year during the coming three years according to the three analysts following the company. That's shaping up to be materially lower than the 13% per year growth forecast for the broader market.

In light of this, it's alarming that American States Water's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From American States Water's 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 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. 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It is also worth noting that we have found 2 warning signs for American States Water (1 is significant!) that you need to take into consideration.

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 have reasonable P/E ratios and have grown earnings strongly.

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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.