Understanding the financials of a company is essential to determining whether or not you should buy its stock. When analyzing stock investors often use the price-to-earnings (P/E) ratio to determine if a stock is cheap or expensive to buy relative to its earnings. Sometimes this ratio can be negative.
When a company has a negative P/E ratio, it often means that the company reported negative earnings. However, it doesn’t always mean that it is a bad investment. Understanding how to determine if a company has a negative P/E ratio and why it might have reported no or negative earnings can help you as you expand your investment portfolio.
Table of Contents:
- What is a negative P/E ratio?
- How to determine if a stock has a negative P/E ratio
- Reasons for a negative P/E ratio
- Should you buy a stock if it has a negative P/E ratio?
- A negative P/E ratio can mean many things
- Frequently asked Questions
What is a negative P/E ratio?
The P/E ratio of a company is used to express the relationship between the price per share and the amount of earnings per share, known as the EPS, which is often released each quarter before a company’s earnings call. The P/E ratio tells investors how much common stock pays per dollar of earnings.
In general, if a company has a high P/E ratio it indicates that the stock valuation is expensive, while a low P/E ratio might mean the stock is cheap. If the P/E ratio is negative, then it often means the company is losing money. Knowing the P/E ratio of company can help you determine the target price of a company.
To understand a negative P/E ratio it’s important to note that the value of a stock can never be negative. So a negative P/E ratio only happens when there’s a negative EPS. A company’s earnings might be negative when it either has no earnings during a quarter or reports a loss.
However, most companies will report a negative P/E ratio as a N/A instead of putting a negative value.
How to determine if a stock has a negative P/E ratio
To find out if a stock has a negative P/E ratio, you first need to understand how to calculate a P/E ratio.
To determine the ratio, you divide the stock price with the earnings per share (EPS). The formula looks like this:
P/E Ratio = Price Per Share (Market Value)/ Earnings Per Share (EPS)
For example, say Company ABC has a share price of $50 and its earnings last year were $10 per share. Using the above formula, you would divide 50 by 10 and get the P/E ratio of 5.
Now let’s say a year later the company’s stock price goes up to $100 but it reported a negative EPS of minus $10. Then it would have a negative P/E ratio of -10. If a company has negative earnings, it often means it was losing money over the past 12 months.
However, there could be other reasons that a company was losing money or had a negative P/E ratio. Having a negative P/E ratio doesn’t always mean that the stock is a bad investment.
Reasons for a negative P/E ratio
Although a P/E ratio indicates a company loss, that doesn’t necessarily mean the company is going bankrupt. There are many reasons a company might have a negative P/E ratio.
- Company is still growing– If a company is a newer company or going through a growth phase, it may experience a negative P/E ratio. It’s not uncommon for it to take a few years for a company to see positive earnings, especially in sectors like pharmaceuticals or technology or if the company was recently listed on Wall Street as an IPO.
- Changes to accounting methods– When a company changes its accounting metrics or policies, it may change the P/E ratio. That’s because there are different ways to calculate the EPS, which is what determines the price-to-earnings ratio.
- Changes in depreciation or amortization– If a company changes its depreciation or amortization policies in a particular year or if there is a market trend, that can cause the company’s P/E ratio to become temporarily negative.
If a company has a negative ratio for a long period of time, such as five years, then investors might want to review its financial statements to see if the company is in good financial health. With Public Premium you can unlock extra investing features including getting access to advanced data metrics like negative P/E and get analysis from Morningstar experts for just $10 a month.
It’s also important to compare the P/E ratio of companies in the same sector, as there may be other factors like stock market conditions or industry-specific conditions that are causing the negative P/E ratio.
Should you buy stock if it has a negative P/E ratio?
Just because a company has a negative P/E ratio doesn’t necessarily mean that the valuation of the company is bad or that it’s going to go out of business. Whether or not you should buy shares of a company with a negative P/E ratio is an investment decision that you need to make based on what makes sense for your portfolio.
For example, if you are looking for growth stocks in anticipation of future earnings you will likely invest in companies that are just starting out and are likely to have a negative P/E ratio. But if you want to invest in companies that have a dividend, then buying shares of a company with a negative P/E ratio might not make sense for your portfolio.
In addition, you should always do your research before investing in any companies. You can find get market news and commentary from industry experts on Public Talks. There are other financial ratios to consider when investing, such as the forward P/E ratio, the cash flow of a company, its growth ratio, net income, earnings yield, its liquidity, and more.
You can find out the financial details of any company on Wall Street on the Public.com app. And with Public Trends you can even get more information and context on certain stocks and ETFs to help you find stocks that could potentially provide a high return of capital in the future. You can also use the Why It’s Moving feature to see when certain stocks move above or below a threshold, which can help you determine whether or not to buy or sell a stock.
A negative P/E ratio can mean many things
When a company reports negative annual earnings, is still in its growth phase, or has changed how it calculates its balance sheet, it could have a negative price-earnings ratio. It doesn’t always mean there’s a problem but it could be a short-term issue with the company’s current earnings.
A lower P/E or negative P/E is part of the business cycle. If a company’s P/E values remain negative, then it might be worth digging deeper. You can find out the P/E ratio of a company on the Public app and you can even get your questions to company executives answered during Public’s Townhalls. With the company-specific analysis, you can keep track of the metrics that matter most, like the P/E ratio to help you pick the best stocks for you.
Frequently asked Questions
What does negative pe ratio mean?
A negative P/E ratio means that the company reported either no earnings per share (EPS) or negative EPS. It often means the company made no money over the last 12 months.
What is the ratio of a company’s debt to its equity?
The ratio of a company’s debt to its equity or D/E ratio is used to determine its financial leverage. It’s determined by dividing a company’s total liability by its shareholder equity.
What is the formula for a negative pe ratio?
The formula for a negative P/E ratio is the same as figuring out the P/E ratio of any company: P/E Ratio = Price Per Share (Market Value)/ Earnings Per Share (EPS)
What does negative pe ratio for ETFs mean?
If a lot of companies have a negative PE ratio, then it can mean that the ETFs who hold shares of those companies could have a lower or even negative price-to-earnings ratio.