Right, it's about aspect ratio, not image size.
Here's the tricky part, though: with an image like your flag example, Photos wants to crop it in landscape mode -- wider than its height --
unless you force it to "think" in portrait mode.
Use the Crop box first to select a portrait-like area -- tall and narrow --
then tap the aspect icon and select 4:5. It will think that you want it to stay tall, and it'll give you a crop boundary to suit (technically 5:4).
First, this is what happens with a landscape pic and choosing the 4:5 crop straight away:
View attachment 584476
Instead, first, manually select a crop boundary that's taller:
View attachment 584477
…which gives you this:
View attachment 584478
Then tap the aspect ratio icon, select "4:5" in the pop up sheet, and you get this:
View attachment 584479
Hit Done, and you're set. Perfect size for the Watch.