This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Houston Wire & Cable Company's (NASDAQ:HWCC), to help you decide if the stock is worth further research. What is Houston Wire & Cable's P/E ratio? Well, based on the last twelve months it is 13.08. That corresponds to an earnings yield of approximately 7.6%.

See our latest analysis for Houston Wire & Cable

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Houston Wire & Cable:

P/E of 13.08 = $3.84 ÷ $0.29 (Based on the trailing twelve months to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

Does Houston Wire & Cable Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Houston Wire & Cable has a lower P/E than the average (17.0) in the trade distributors industry classification.

Houston Wire & Cable's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Houston Wire & Cable, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Houston Wire & Cable's earnings per share fell by 47% in the last twelve months. And it has shrunk its earnings per share by 18% per year over the last five years. This could justify a pessimistic P/E.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does Houston Wire & Cable's Debt Impact Its P/E Ratio?

Net debt totals a substantial 124% of Houston Wire & Cable's market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Verdict On Houston Wire & Cable's P/E Ratio

Houston Wire & Cable has a P/E of 13.1. That's below the average in the US market, which is 18.1. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations.

Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: Houston Wire & Cable may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.