Investors have many different tools available to help them evaluate companies, their performance and how viable they are as investment opportunities. Among those tools is the price-to-earnings (P/E) ratio. Benjamin Graham, the father of value investing, described this tool as one the quickest ways to determine a stock's viability and potential for growth.
But what happens when a company doesn't have a P/E ratio? How should you analyze this as an investor? Read on to find out more.
Investors and analysts will often look to a company's price-to-earnings (or P/E) ratio to gauge if its stock is over or undervalued relative to its competitors and to the broader market. In simple terms, the P/E ratio is what an investor pays for $1 of a company's earnings.
P/E ratio = Market value per share ÷ Earnings per share
The P/E ratio allows for quick apples-to-apples comparisons across stocks that are in the same industry sector or within the same stock over different time periods.
It is typically expressed as a multiple so a company with a P/E ratio of 15x would indicate its shares are trading at 15 times its earnings. If a direct competitor of that company has a P/E of 10x, it may be safe to assume that this company is a better value to buy than the higher priced 15x P/E stock.
But sometimes, these ratios don't exist and are expressed as N/A.
How Companies Get a "N/A" for a P/E Ratio
An "N/A," which stands for not applicable or not available, will sometimes be reported as a stock's price-to-earnings ratio. You'll often notice these on a chart for a security. This can mean one of two things.
The first and simplest explanation is that there is simply no data available at the time of reporting. This will be the case with a newly listed company like an initial public offering (IPO) that has yet to release its earnings report.
The second (and more common) reason would be that the P/E ratio of a stock would be calculated to be a negative number. Negative P/E ratios are mathematically possible, but because they are generally not accepted by the financial community, they are usually reported as "N/A" or not applicable.
Obviously, it is not possible for a stock to have a negative price in the market, so the negative part of the P/E ratio must come from the EPS of the company being negative. An N/A will also appear if earnings are exactly $0 for some period since you cannot divide by zero.
How to Handle a "N/A" P/E Ratio
So what should you do when you come across a company with a P/E ratio that reads N/A?
Investors can interpret seeing "N/A" as the company reporting a net loss. They should be aware they are buying shares of a company that has lost money. Of course, this is not always a reason to worry. High-growth companies in the semiconductor, biotech or internet sectors often lose money in the first few years as they experience rapid expansion or growth, grow their customer base, and develop new products and markets. The expectation is that eventually, the company will turn a profit, but that in the short-run they have to burn cash in order to accelerate growth and revenue. Amazon is a prime example of a company that lost money year after year, yet still remains a high flyer on the market in terms of its share price and market capitalization.
Companies with an N/A for their P/E ratio, however, may also indicate a sign of trouble. If a company has historically had a track record of profits and then turns negative, it could mean that they could be in financial trouble or in a dying industry.
The Bottom Line
When an investor sees that a company has a P/E ratio that reads N/A, it may be a warning sign that a company is running a loss. It may also mean it's too new to the investment world. Frankly, the P/E ratio is just one of several metrics used for fundamental analysis and its interpretation should be taken in conjunction with other financial ratios, industry trends, historical performance across peers and the market as a whole.