With a price-to-earnings (or "P/E") ratio of 20.9x American States Water Company (NYSE:AWR) may be sending 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 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the 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. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.
How Is American States Water's Growth Trending?
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.
If we review the last year of earnings growth, the company posted a terrific increase of 59%. Pleasingly, EPS has also lifted 44% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 1.3% each year as estimated by the three analysts watching the company. With the market predicted to deliver 10% growth per year, the company is positioned for a weaker earnings result.
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.
The Final Word
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We've established that American States Water currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with American States Water (at least 1 which is concerning), and understanding these should be part of your investment process.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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