Negative Price to Earning Ratio

Price to earnings ratio is the financial ratio that measures company’s share price to its earnings per share. It represents the number of years investors spend to recover their investment.  It is the amount the investors need to invest to earn a dollar from the company.

A negative price to earnings happens when the company is making a loss. When the company makes a net loss, it is a negative figure. So when we divide share price over the negative number, we will get the negative price-to-earning ratio.

A negative Price to Earning Ratio means that investors are investing in the loss-making company. Their investments are not generating any profit but lose value over time due to operating loss.

PE Ratio is Calculated by Following Formula:

Price to-earning ratio is the comparison between share price and earnings per share. We calculate the ratio by dividing the price per share over earnings per share.

\[ PE / Ratio = {Price \ per\ Share \over Earning \ per \ Share}\]

Price to earnings is the ratio which the investors use to evaluate company valuation by comparing the share price with earning per share. It is a common way to check if the stock is cheap or expensive. Low PE ratio means that the stock is cheap while a high PE means the stock is expensive. Expensive stock will take a longer time to recover the initial investment. The cheap stock will be recovered in a shorter time.

It is the financial ratio used by the investor the determine how fast they can make by investing in the company. For example, if the company has PE of 2.5. It means we need 2.5 years to earn the invested money if earning per share remains the same. In other words, investors need to pay $ 2.5 now for the earning of $ 1 per year.

However, PE ratio will be negative if the company is not making any profit but loss. Even company is making losses, the share price still positive. So mathematically, the PE ratio will be negative. It means the investor will invest money for the annual loss.

Negative Price to Earning Ratio Analysis

Low PE ratio shows that the stock is selling at a cheap price, but when it goes beyond zero, it will be another story to discuss. Some people may hesitate to invest with negative PE as they will lose their money over time due to annual loss. On the other hand, some people look at negative PE stock as an opportunity when the company going to make a profit in the future. Whatever reasons, the negative PE means that:

  • Company is not making any profit in the last 12 months: we usually calculate PE ratio one per year after company issuing financial statements. The current negative PE shows that the company made losses in the last accounting period.
  • Startup company: the start-up company usually faces a huge loss during the initial stages. The company is trying to gain market share to monetize in the future. They pure a lot of money into marketing expense while the revenue is almost zero. As the result, they will be in a huge loss.
  • Change in accounting standard: as we know that the accounting profit is very subjective and it will be change base on the accounting standard, accounting estimate, and management judgment. For example, if the company change from US GAAP or IFRS, there will be a huge hit to the P&L. It can be an unusual profit or loss which will lead to negative PE. However, it will go back to normal in the next accounting period.
  • Unusual impact on the income statement: the company making loss may not relate to their performance but it is the major hit by other factors such as penalty from the government, lawsuit, and so on. It is an unexpected event that causes the loss and it is not highly likely to happen again soon.
  • Company in the growth stage: most tech companies always face a huge loss at the beginning as they are increasing the market share. They will spend whatever amount to obtain market share and make a profit later.

Negative Price to Earning Ratio is Confusing

When PE ratio is positive, it represents the amount we invest with the amount we earn annually. But when it’s negative, is it present the amount of we invest with the amount we lose annually?

For example, company A & B’s share price is $100, however, their EPS is different. Company A’s EPS is negative $ 10 while company B is negative $0.1.

If we calculate PE it would be:

  • Company A’s PE = $100/-10 = -10
  • Company B’s PE = $100/-0.1 = -1,000

Both companies have PE of -10 and -1,000 but it means that company B only loses 0.1 per share and it is highly likely to make a profit soon while company A lose $ 10 per year.  So we should look carefully when the PE ratio is less than zero, the small number is not mean the company has a huge loss.

It is almost impossible to evaluate a company with a negative price-to-earning ratio. We need to look at the other factors besides this ratio.

Should We Invest in Company with Negative PE?

It is the common question we receive from the investors, and it is hard to answer if base only on the PE alone. Avoid negative PE is like avoiding the company which is making losses. If it is a new company which is growing, we will lose a chance and the price will significantly increase after they make a profit. For example, Amazon started in 1994 and making the first profit in 2001, it is around 7 years for them to make the first profit. It means that they had a negative PE ratio for 7 years.

However, not all companies will end up like Amazon, some companies will go forever after a few years of loss. So we cannot assume that the negative price to earnings ratio is a good sign of good investment.