Watts Water Technologies, Inc.'s (NYSE:WTS) price-to-earnings (or "P/E") ratio of 25.6x 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 18x and even P/E's below 11x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent earnings growth for Watts Water Technologies has been in line with the market. It might be that many expect the mediocre earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Watts Water Technologies?

There's an inherent assumption that a company should outperform the market for P/E ratios like Watts Water Technologies' to be considered reasonable.

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. Still, the latest three year period has seen an excellent 83% overall rise in EPS, in spite of its uninspiring short-term performance. 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 7.7% per year during the coming three years according to the nine analysts following the company. That's shaping up to be materially lower than the 11% each year growth forecast for the broader market.

In light of this, it's alarming that Watts Water Technologies' 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

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 Watts Water Technologies' 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. 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 1 warning sign for Watts Water Technologies you should be aware of.

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

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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.