What Does a Negative P/E Ratio Mean? A Simple Guide for Investors

Many companies have revenue - which is money generated usually from sales.

But not every company has profits - which is money that is left over from revenue after operational costs, taxes, etc.

That makes it difficult to value these types of public companies using a traditional metric like P/E ratio.

Why? P/E ratio is the price to earnings ratio, so a company has to have earnings in order to do the metric.

Otherwise, you end up with a negative P/E ratio.

Here's the truth: A negative P/E ratio isn't a red alert or a hidden value signal. 

It's just telling you one simple thing - the company is currently losing money. 

And while that might sound scary, it's actually pretty common, especially for growing companies that are investing heavily in their future.

Let's break down exactly what a negative P/E ratio means and how smart investors handle it.

Speaking of smart investors: What to get an edge on the rest of Wall Street?

Subscribe to Market Briefs Pro - our weekly investing report that gives you all of the data and research on specific potential stock market opportunities you need to make smarter investment decisions.

Subscribe here.

What Is a P/E Ratio, Really?

Before we dive into the negative side of things, let's nail down the basics.

The P/E ratio (price-to-earnings ratio) tells you how much investors are willing to pay for every dollar of profit a company earns. It's one of the most popular valuation metrics in investing.

Here's the simple formula:

P/E Ratio = Stock Price ÷ Earnings Per Share (EPS)

To get earnings per share, you divide the company's net income by its total shares outstanding.

Let's use a real example. Say Coca-Cola's for example, stock is trading at $70 per share, and it has earnings per share of $2.43. (these numbers are hypothetical)

$70 ÷ $2.43 = P/E ratio of 28.8

This means investors are willing to pay almost $29 for every $1 that Coca-Cola earns in profit.

Warren Buffett usually likes to invest in companies between 15-30 as the value matches the amount spent for him.

But there’s no hard and fast rule - the P/E ratio should be looked at with many other financial metrics to get the full picture.

When P/E Ratios Turn Negative

But again, the P/E ratio formula only works when a company has positive earnings. 

But what happens when a company doesn't have positive earnings?

What if the company is losing money?

When earnings per share (EPS) is negative, the math creates a negative P/E ratio. 

And since a negative P/E ratio doesn't make intuitive sense (you can't really pay "negative dollars" for a dollar of earnings), most finance sites will just show it as "N/A" or leave it blank.

A negative P/E ratio simply means the company is unprofitable right now.

The company is spending more money than it's bringing in. 

In short - its expenses exceed its revenue, so it has negative net income.

Why Would Anyone Invest in an Unprofitable Company?

Why would anyone put money into a company that's actively losing money?

Here's the thing: Many companies, particularly ones in their growth stage, operate at a loss for years. 

They're not profitable yet because they're investing heavily in growth.

These companies are:

• Hiring talent aggressively.
• Building infrastructure.
• Spending on research and development.
• Expanding into new markets.
• Acquiring customers at a loss to build market share.

These companies are betting on future profitability. They're sacrificing short-term profits for long-term dominance.

Investors who buy these stocks aren't buying what the company is today. 

They're buying what it could become in three, five, or ten years, so they're factoring in that growth potential.

Growth companies come with risk like:

• Some of these companies may never become profitable.
• Their business model might not work at scale. 
• Competition might crush them before they get there.

But there could also be massive rewards. 

Getting in early on the next Amazon or Netflix? That's the dream that keeps growth investors hunting for tomorrow's winners today.

All investing has risks and nothing is guaranteed, so always do your own due diligence.

How to Value Companies with Negative P/E Ratios

If the P/E ratio doesn't work for unprofitable companies, what should you use instead?

Some investors P/S ratio (price-to-sales ratio) to value companies with a negative P/E ratio.

The P/S ratio compares a company's stock price to its revenue, not its profit. This works perfectly for companies that aren't profitable yet but are generating sales.

Here's the formula:

P/S Ratio = Stock Price ÷ Revenue Per Share

Let's say a company's stock is trading at $70 per share and it has revenue per share of $47.

$70 ÷ $47 = P/S ratio of 1.49.

This tells you what investors are willing to pay for every dollar the company earns in sales.

The same concept applies as with P/E ratios: 

A higher P/S ratio means investors are willing to pay a premium to own shares in that company. 

It suggests the market sees strong growth potential, even if current profits aren't there yet.

When to Use P/S Instead of P/E

Here's your quick decision guide:

The P/S ratio isn't perfect, but it gives you a way to compare unprofitable companies to each other and to understand how the market is valuing their revenue generation.

Just remember: Revenue without profit is only part of the picture. 

A company can have growing revenue but still be burning through cash. 

That's why investors also look at metrics like gross margins, operating expenses, and cash flow to understand if the path to profitability is realistic.

The Bottom Line on Negative P/E Ratios

A negative P/E ratio isn't inherently good or bad - it's just information.

It tells you the company is currently unprofitable. 

From there, you need to ask deeper questions:

• Why is the company losing money?
• Is it investing in growth, or are there fundamental business problems?
• What's the path to profitability?
• How much cash does the company have to fund operations until it breaks even?
• What does the competitive landscape look like?

Some of the world's most successful companies spent years operating at a loss before they turned the corner. 

Amazon famously didn't turn a consistent profit until nearly 10 years after going public. Tesla burned cash for over a decade before achieving sustained profitability.

But plenty of other companies with negative P/E ratios never made it. They ran out of cash, couldn't scale, or got crushed by competition.

The key is understanding what you're buying. 

When a company has a negative P/E ratio, you're not buying current earnings - you're buying a bet on the future. 

Make sure you understand what that future looks like and whether the company has what it takes to get there.

Our market analysts are researching companies that they believe have a long-term future every week in Market Briefs Pro.

These are potential opportunities that smart money is moving into right now.

Don’t miss out - Subscribe to Market Briefs Pro today.