Introduction
When you first begin to learn about investing, one of the first things you learn is the P/E ratio. It is one of the most commonly used measurements in stock analysis when trying to determine if a stock is over-priced or under-priced.
But what do you do when you’re analyzing a company and the P/E ratio shows a “Negative PE Ratio“? It a great company? Is it a glitch? It may feel strange, but a Negative PE Ratio is actually a simple metric that communicates something very specific about a company.
This article will explain what a Negative PE Ratio is, why this occurs, and how you can use the information to help you make better investment decisions.
First, A Quick Refresher: What is a P/E Ratio?
Before we dive into the negative, let’s quickly recap the standard Price-to-Earnings (P/E) ratio. The formula is simple:
P/ERatio=(PriceperShare)/(EarningsperShare)
In simple English, the P/E ratio tells you how much investors are paying for each dollar of company profits (earnings).
- When the P/E ratio is high (of say 50), it means investors are paying $50 for $1 of earnings. This probably means investors expect high growth in the future.
- When the P/E ratio is low (of say 10), it means investors are paying $10 for $1 of earnings. This could mean the stock is cheap or there are low growth prospects for the company.
So, What is a Negative PE Ratio?
A Negative PE Ratio occurs when a company’s Earnings per Share (EPS) is negative.
Recall the formula. A stock price cannot be negative so the only logical way for a P/E Ratio to be negative is for the “Earnings per Share” to be a negative number. Negative EPS indicates that the company actually lost money over the past year instead of making a profit.
Therefore, when you see a Negative PE Ratio, the immediate conclusion is: This company is not profitable at present. Most financial sites will either display this negative number or will just show “N/A” (Not Applicable) because a negative P/E is not useful when trying to make a direct comparison.
Why Would a Company Lose Money?
A Negative PE Ratio does not mean you should avoid the stock. There are a variety of reasons, both good and bad, that may cause a company to report negative earnings. The key to smart stock analysis is to understand why.
- It is a High-Growth Startup: Many new tech or bio-tech companies intentionally spend years unprofitably. While these companies may lose money, they are spending that money on research and development, marketing expenses, and general growth, in order to capture a larger portion of the market. The investors are betting on future positives not current ones.
- It is a Cyclical Company in a Downturn: Some industries have an annual cycle, e.g. airlines, construction, or manufacturing. A company in a cyclical industry may report losses during a recession, and then report profits during an economic boom.
- It has a One-Time Major Expense: The company may have reported profits from normal operations, but had to pay a one-time major expense. The expense may have come from a lawsuit, or a major factory shutdown, or a restructuring expense.
- The company is in trouble: This is the worst reason, and the most disconcerting. The company may be losing market share, may have too much debt, or is not well-run. In this case, the Negative PE Ratio is a warning sign.
How to Use a Negative PE Ratio in Your Stock Analysis
A Negative PE Ratio is neither a buy signal nor a sell signal. It’s a signal that you need to put on your detective hat and go through some more analysis of the stock.
- Don’t Compare It: You can’t compare a negative P/E to a positive P/E. A company with a P/E of -15 isn’t “cheaper” than a company with a P/E of 20. The metric has no comparative value when it is negative.
- Look at the “Why”: Use the list above. Is the company an exciting startup or is it a business going down in flames? Read the company’s latest financial reports to determine the why.
- Use Other Metrics: With P/E off the table, a good stock analysis requires some other tools. Look at its Price-to-Sales (P/S) ratio, Price-to-Book (P/B) ratio, and the company’s cash flow. These other ratios can show you a much better picture of the financial health of the company.
Acting on Your Findings with the Right Platform
Once you have conducted stock analysis, you will want to approach it wisely. Whether you reach the conclusion that a company which has a Negative PE Ratio is an undiscovered opportunity or to leave it a lone wolf, you will need a proper platform. That is where modern brokers come in.
- For Easy Trading: If you want to take action on trading stock CFDs based on the information you derive from your analysis, both Capitalix and Trade EU Global are accessible and simple-to-use user interfaces.
- For Complex Analysis: If your analysis is information-heavy and tech-driven, Algobi and SuxxessFx and eager on its accessibility with advanced tools and analysis to compliment your analysis.
- For Community Trading: On the social trading side, SmartSTP and CapPlace platforms provide social or copy trading to observe how traders interpret the market.
- For Quick Decisions: If you want to take action fast, anywhere, the FX Road and Tradgrip mobile apps are an essential companion, whereas FirstECN is designed for speed.
Conclusion
A Negative PE Ratio is one of the most misinterpreted metric in investing. A Negative PE Ratio is not synonymous with a bad stock; it simply means the company is not profitable as of now, and your responsibility as an investor is to figure out why.
If you think of it as an initial step of investigation, you will find great growth opportunities that other investors miss. Always remember and keep your toolkit for stock analysis varied and partner with trusting platform to execute your intelligent, researched stock trading plan.
FAQs
- What does a Negative PE Ratio mean in simple terms?
It simply means the company has lost money over the last 12 months. Since earnings are negative, the P/E calculation results in a negative number.
- Is a stock with a Negative PE Ratio a bad investment?
Not necessarily. A young, fast-growing company might have a negative P/E because it’s investing heavily in its future. However, it can also be a sign of a company in trouble. You must do more research.
- Can a company’s P/E ratio go from negative to positive?
Yes, absolutely. If a company that was losing money becomes profitable, its Earnings per Share (EPS) will turn positive, and it will then have a positive P/E ratio.
- How can I analyze a stock if it has a negative P/E?
Since you can’t use the P/E ratio for comparison, you should use other financial metrics like the Price-to-Sales (P/S) ratio, Price-to-Book (P/B) ratio, and analyze the company’s debt and cash flow.
- Why do some websites show “N/A” instead of a Negative PE Ratio?
Many financial data providers show “N/A” (Not Applicable) because a negative P/E is not useful for comparing valuations between companies. It is considered a meaningless figure for that purpose, so they remove it to avoid confusion.
