American Water Works Company, Inc.'s (NYSE:AWK) price-to-earnings (or "P/E") ratio of 26.6x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 17x and even P/E's below 9x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings that are retreating more than the market's of late, American Water Works Company has been very sluggish. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

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Is There Enough Growth For American Water Works Company?

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 frustrating 33% decrease to the company's bottom line. Regardless, EPS has managed to lift by a handy 29% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 6.9% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 12% per annum, which is noticeably more attractive.

In light of this, it's alarming that American Water Works Company'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. 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 Water Works Company's P/E?

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 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.

Plus, you should also learn about these 4 warning signs we've spotted with American Water Works Company (including 1 which is a bit concerning).

If these risks are making you reconsider your opinion on American Water Works Company, explore our interactive list of high quality stocks to get an idea of what else is out there.

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.