Understanding Negative P/E Ratios For ETFs

April 15, 2014

Do negative earnings show up in an ETF’s price-to-earnings ratio? It depends on who you ask.

This just in: Sometimes firms lose money.

Volatility in the biotech sector, and the iShares Nasdaq Biotechnology ETF (IBB | A-46) in particular, got me thinking about this, while recent news coverage focused on earnings in growth stocks. When I looked at our fund report on IBB, its large and negative price-to-earnings ratios stood out.

While it stands to reason that some firms in a growth industry with high research and development costs like biotech may not be profitable, comparing aggregate P/E ratios of ETFs with each other is tricky when the P/Es are negative.

Here’s a snapshot of the ETF.com fund report for IBB. Here at ETF.com, we display negative P/E ratios, while many issuers and data providers don’t (more on this in a moment).

IBB snap2

Note the trailing 12 months P/E’s underlined in blue: -208.8 for IBB versus -125.1 for our neutral biotech benchmark.

Is that a good thing?

In fact, the two numbers relative to each other don’t tell us much. All we know for sure is that, in the aggregate, both the benchmark and the fund have negative earnings.

To break it down, there are two ways to look at negative P/Es in a fund context, and they conflict with each other.

The first is to imagine a constant share price, say, $20. Then, picture earnings per share ranging from $1.00 to -$1.00. As earnings approach zero from the positive side, P/Es get huge. Once earnings pass through zero and into negative territory, P/Es are both huge and negative. As losses increase, the P/Es stay negative, but the numbers get smaller as an absolute value. Here’s a chart of this example:

Example 1 Const Shr Price

 

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