Can Stocks Have a Negative Price-to-Earnings Ratio?
The P/E ratio is generally used as a valuation tool for assessing a company's stock. It indicates a company's health as positive P/E ratio shows the company's good health and negative shows that the company is financially unhealthy.
The price-to-earnings (P/E) ratio is a measure of a company’s value that investors use to determine the value of a stock. It is determined by dividing the market price per share by the earnings per share (EPS). When the P/E ratio is higher, it indicates that investors expect growth in earnings or have trust in the company’s potential.
Start trading stocks now with RoboForex!Basics of the P/E indicator
The Price-to-Earnings (P/E) ratio is a financial ratio that compares a company's stock market price per share to its earnings per share (EPS). It is computed by dividing a company's market price per share by earnings per share during a specific time period, often the previous year.
The P/E ratio of a company shows how much investors are ready to pay for every dollar of earnings that is generated by the company. A higher P/E ratio indicates that investors expect more future profit, whilst a lower P/E ratio may show lower expectations or undervaluation of the stock.
Why the P/E ratio can be negative
A negative P/E ratio is a rare occurrence but can be seen in the cases of companies that are experiencing huge financial challenges, like financial loss, a downturn in corporate operations, or accounting changes that result in producing a negative earning for the company. Here are a few reasons why the P/E ratio of a company can come out as negative:
-
Earning losses. A very common reason the evaluation of a company shows negative earnings per share is because their business might be currently undergoing substantial financial losses. And this is surely a turnoff for an investor who’s looking to buy the company’s shares
-
Startups generally have the tendency to invest all of their profits in their operations, which can give a negative earning per share, and eventually, the P/E ratio can also become negative. That’s why it can become tricky for investors to judge the value of the company based on the P/E ratio alone
-
Cyclic businesses generate profit in one business season, and in the other business season, they might earn close to nothing. When the balance sheet of the company is evaluated during this off-season, the earnings per share of the company can come out as negative. Which eventually makes its P/E ratio negative, too. That’s why depending on the P/E ratio without understanding a business might be a terrible investment move
Is it worth buying a stock with a negative P/E ratio?
Just because a company has a negative P/E ratio doesn’t mean that the company is going bankrupt or the company is facing losses. It might happen that the company is showing a negative P/E ratio because of the reasons we mentioned above.
Moreover, your investment decision should depend on your overall investment strategy and not just the P/E ratio of a stock.
For example, if you’re looking to make a bank, then investing in high-growth stocks of start-ups might make sense for you, and in most cases, the P/E ratio of these startups might come across as negative.
But if you are someone who is risk-averse and only wants to generate dividend income through your investments, then it is the Irrational idea to invest in a stock that has a negative P/E ratio.
If you are a beginner to the stock market and trying to navigate this complex world, here is an article that can help you better understand the market and investing tips that can help make you a bank: Stock Marketing Basics: 10 Tips for Investors.
Best stock brokers 2024
Conclusion
Finally, a negative P/E ratio shows that the company is now losing money per share, making it a more difficult statistic for traditional valuation research. Investors evaluating stocks with negative P/E ratios should do extensive due diligence, taking into account the causes for the negative profits, the company's financial health, and its future development prospects. It is critical, as with every investing decision, to connect your choices with your risk tolerance, financial goals, and overall investment plan.
FAQs
What does a zero P/E ratio mean?
The PE ratio is a mathematical ratio. It can never be zero because for that you need the stock price to be Zero which is never possible in any stock exchange.
What Is a Negative P/E Ratio?
A negative P/E ratio indicates that the company is losing money or has negative earnings.
Is a Negative Price-earning Ratio A Bad Sign for Investors?
It is not necessarily bad, but it definitely is a danger sign for investors, and it warns investors to be aware before they invest in this stock.
At what PE ratio is a stock undervalued/overvalued?
For example, if a company has a bad year and makes $10 in EPS, the new P/E ratio is $100 divided by $10, or 10 times ($100/$10 = 10). Most people would consider the company to be overvalued at a P/E of 50 but possibly undervalued at 10.
Glossary for novice traders
-
1
Broker
A broker is a legal entity or individual that performs as an intermediary when making trades in the financial markets. Private investors cannot trade without a broker, since only brokers can execute trades on the exchanges.
-
2
Trading
Trading involves the act of buying and selling financial assets like stocks, currencies, or commodities with the intention of profiting from market price fluctuations. Traders employ various strategies, analysis techniques, and risk management practices to make informed decisions and optimize their chances of success in the financial markets.
-
3
Investor
An investor is an individual, who invests money in an asset with the expectation that its value would appreciate in the future. The asset can be anything, including a bond, debenture, mutual fund, equity, gold, silver, exchange-traded funds (ETFs), and real-estate property.
-
4
CFD
CFD is a contract between an investor/trader and seller that demonstrates that the trader will need to pay the price difference between the current value of the asset and its value at the time of contract to the seller.
-
5
Social trading
Social trading is a form of online trading that allows individual traders to observe and replicate the trading strategies of more experienced and successful traders. It combines elements of social networking and financial trading, enabling traders to connect, share, and follow each other's trades on trading platforms.
Related Articles
Team that worked on the article
Upendra Goswami is a full-time digital content creator, marketer, and active investor. As a creator, he loves writing about online trading, blockchain, cryptocurrency, and stock trading.
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO).