diff --git a/internal/e2e/watch_local_files_listed_after_external_files/BUILD b/internal/e2e/watch_local_files_listed_after_external_files/BUILD
new file mode 100644
index 00000000..908120a9
--- /dev/null
+++ b/internal/e2e/watch_local_files_listed_after_external_files/BUILD
@@ -0,0 +1,7 @@
+load("@io_bazel_rules_go//go/tools/bazel_testing:def.bzl", "go_bazel_test")
+
+go_bazel_test(
+    name = "watch_local_files_listed_after_external_files_test",
+    srcs = ["watch_local_files_listed_after_external_files_test.go"],
+    deps = ["//internal/e2e"],
+)
diff --git a/internal/e2e/watch_local_files_listed_after_external_files/watch_local_files_listed_after_external_files_test.go b/internal/e2e/watch_local_files_listed_after_external_files/watch_local_files_listed_after_external_files_test.go
new file mode 100644
index 00000000..89f83fa5
--- /dev/null
+++ b/internal/e2e/watch_local_files_listed_after_external_files/watch_local_files_listed_after_external_files_test.go
@@ -0,0 +1,101 @@
+package simple
+
+import (
+	"io/ioutil"
+	"log"
+	"os"
+	"path/filepath"
+	"runtime"
+	"testing"
+
+	"github.com/bazelbuild/bazel-watcher/internal/e2e"
+)
+
+const nestedBuild = `
+exports_files(["exclaim.sh"])
+`
+
+const nestedScript = `
+printf "!"
+`
+
+const nestedModuleFile = `
+module(
+	name = "nested_module",
+	repo_name = "nested",
+)
+`
+
+const mainFiles = `
+-- BUILD --
+genrule(
+    name = "gen_test",
+    srcs = ["@nested//:exclaim.sh", "greeting.sh"],
+    outs = ["test.sh"],
+    cmd = "cat \"$(location greeting.sh)\" \"$(location @nested//:exclaim.sh)\" > \"$@\"",
+    executable = True,
+)
+sh_binary(
+    name = "test",
+    srcs = ["test.sh"],
+)
+-- greeting.sh --
+printf "hello"
+`
+
+const mainModuleFile = `
+module(name = "primary")
+bazel_dep(name = "nested_module", repo_name = "nested")
+local_path_override(
+    module_name = "nested_module",
+    path = "./nested/",
+)
+`
+
+const greetingAlt = `
+printf "hello2"
+`
+
+var nestedWd string
+
+func TestMain(m *testing.M) {
+	e2e.TestMain(m, e2e.Args{
+		Main:              mainFiles,
+		ModuleFileContent: mainModuleFile,
+		SetUp: func() error {
+			// Create a nested module in a subfolder.
+			nestedWd, _ = filepath.Abs("nested")
+
+			// Manually create files in the nested module.
+			if err := os.Mkdir(nestedWd, 0777); err != nil {
+				log.Fatalf("os.Mkdir(%q): %v", nestedWd, err)
+			}
+			for file, contents := range map[string]string{
+				"BUILD.bazel":   nestedBuild,
+				"exclaim.sh":    nestedScript,
+				"MODULE.bazel":  nestedModuleFile,
+			} {
+				if err := ioutil.WriteFile(filepath.Join(nestedWd, file), []byte(contents), 0777); err != nil {
+					log.Fatalf("Failed to write file %q: %v", file, err)
+				}
+			}
+
+			return nil
+		},
+	})
+}
+
+func TestRunWithModifiedFile(t *testing.T) {
+	if runtime.GOOS == "windows" {
+		t.Skipf("--override_repository is not implemented in windows")
+	}
+
+	ibazel := e2e.SetUp(t)
+	ibazel.Run([]string{}, "//:test")
+	defer ibazel.Kill()
+
+	ibazel.ExpectOutput("hello!")
+
+	ioutil.WriteFile("greeting.sh", []byte(greetingAlt), 0777)
+	ibazel.ExpectOutput("hello2!")
+}
diff --git a/internal/ibazel/ibazel.go b/internal/ibazel/ibazel.go
index 9796b06d..97ae24a3 100644
--- a/internal/ibazel/ibazel.go
+++ b/internal/ibazel/ibazel.go
@@ -647,7 +647,6 @@ func (i *IBazel) labelsToWatch(labels []string) ([]string, error) {
 			if realPath, ok := localRepositories[repo]; ok {
 				label = strings.Replace(target, ":", string(filepath.Separator), 1)
 				toWatch = append(toWatch, filepath.Join(realPath, label))
-				break
 			}
 			continue
 		}
diff --git a/internal/ibazel/ibazel_test.go b/internal/ibazel/ibazel_test.go
index 99ea41a7..d2122d86 100644
--- a/internal/ibazel/ibazel_test.go
+++ b/internal/ibazel/ibazel_test.go
@@ -653,3 +653,47 @@ func TestParseTarget(t *testing.T) {
 		})
 	}
 }
+
+func TestIBazelConvertLabelsToPaths(t *testing.T) {
+	log.SetTesting(t)
+
+	i, mockBazel := newIBazel(t)
+	defer i.Cleanup()
+
+	outputBase := t.TempDir()
+	if err := os.Mkdir(filepath.Join(outputBase, "external"), 0o700); err != nil {
+		t.Errorf("failed to create external directory: %v", err)
+		t.FailNow()
+	}
+	mockBazel.SetInfo(map[string]string{
+		"output_base":  outputBase,
+		"install_base": t.TempDir(),
+	})
+
+	repo := t.TempDir()
+	if err := os.Symlink(repo, filepath.Join(outputBase, "external", "repo")); err != nil {
+		t.Errorf("failed to create symlink to repo: %v", err)
+		t.FailNow()
+	}
+
+	labels := make([]string, 0, 1)
+	labels = append(labels, "//first:file")
+	labels = append(labels, "@repo//first:file")
+	labels = append(labels, "//second:file")
+	labels = append(labels, "@repo//second:file")
+	toWatch, err := i.labelsToWatch(labels)
+	if err != nil {
+		t.Errorf("Error converting labels to paths: %s", err)
+	}
+
+	expectedToWatch := make([]string, 0, 1)
+	expectedToWatch = append(expectedToWatch, filepath.Join("first", "file"))
+	if runtime.GOOS != "windows" {
+		expectedToWatch = append(expectedToWatch, filepath.Join(repo, "first", "file"))
+	}
+	expectedToWatch = append(expectedToWatch, filepath.Join("second", "file"))
+	if runtime.GOOS != "windows" {
+		expectedToWatch = append(expectedToWatch, filepath.Join(repo, "second", "file"))
+	}
+	assertEqual(t, expectedToWatch, toWatch, "Resulting paths")
+}