comparing negating P/E ratios?

Question

How do you compare company A with -10 P/E (trailing 12M earnings) vs. a company B with 30 P/E. Which company is the market more enthusiastic about? When you have positive P/E values the higher number generally represents greater growth expectations when looking within the same sector. For example a company with PE of 40 is anticipated to have higher earnings growth than a company with PE 20. But what about negative PEs? The market anticipates company B will have good earnings growth but company A has negative earnings.

Answer 1

Well, to tell you the truth, I mostly ignore companies with negative earnings. The only exceptions are start up companies that have not generated enough revenue yet to meet their overheads. These are a special exception. They are purchased not based on earnings growth but based on sales growth.

As for companies with pes of 40. I avoid them like the plague. They are disasters waiting to happen. One bad quarter and they loose half their value over night.

Answer 2

That is a general limitation of the P/E ratio. A company may be a very good investment, however a P/E ratio will not be helpful when the company has long-term growth prospects, but experiences a year where profits or negative.

Other types of ratios include the Price to Sales, Price to Book Value of Equity, and Price to Cash Flow.

Each have their advantages and limitations.

The following articles at Fool.com provide excellent explanations on ways to use the P/BV and P/S measures as alternatives.

Answer 3

P/E are used as a first pass search meassure. Again after the required P/E criterion is met, then other fundamentals are looked into like Sales and other performance ratios. It is not P/E alone the decision criterion.