Working with all of his players who did not travel to the World Cup, Mikel Arteta fielded a strong XI from the first whistle as Marquinhos and Eddie Nketiah struck either side of Keinan Davis's response.
However, after the Gunners made 10 changes at the break to hand opportunities to their up-and-coming academy stars, Watford struck through Davis, Yaser Asprilla and Joao Pedro to seal a six-goal success.
Arsenal's starting lineup featured the likes of Gabriel Magalhaes, Kieran Tierney and captain Martin Odegaard, and they deservedly drew first blood in the 28th minute when Marquinhos curled into the far corner from the edge of the box.
Watford only took eight minutes to find a response, though, as Gabriel failed to cut out a long ball over the top, allowing Davis to ghost in and round Karl Hein for the leveller.
The Hornets' joy was short-lived, as Nketiah powered home a header from Tierney's inch-perfect cross before Arteta rang the changes at the break.
The likes of Reuell Walters, Lino Sousa and 15-year-old Ethan Nwaneri, who became the Premier League's youngest-ever player against Brentford back in September, were all brought on for the second 45 minutes.
Watford did not take long to level the scores for a second time against an inexperienced Arsenal side, as Davis was left unmarked to head home from Joseph Hungbo's free kick.
Just before the hour mark, the Championship side took the lead at London Colney for the first time, as Pedro surged forward and laid off Asprilla, who cut inside before firing home into the top corner.
Pedro then turned scorer for Slaven Bilic's men in the 77th minute, picking up the ball on the left-hand side and dribbling through a sea of red shirts before picking out the bottom corner with a deflected effort.
Arsenal will now turn their attention to their warm-weather training camp in Dubai, where they will compete in the Dubai Super Cup with AC Milan, Lyon and Liverpool.
The Gunners are due to take on the French side on December 8 before clashing with Milan five days later, and they also have a friendly pencilled in with Juventus on December 17.
Sitting five points clear of Manchester City at the top of the Premier League table, Arsenal resume their competitive duties with the visit of West Ham United to the Emirates on Boxing Day.