Is a Negative P/E Ratio a Bad Sign for Investors?

Price-to-earnings (P/E) ratio is one of the earliest valuation concepts that equity investors encounter. It is relatively simple to calculate and widely discussed in market commentary.

However, its interpretation becomes complex when earnings turn negative. A negative P/E ratio often raises questions, particularly among newer investors, about whether it signals underlying stress in a company.

But is a negative P/E ratio a cause for alarm? Not necessarily. This article tells you more about this metric and helps you understand how to interpret a negative P/E ratio.

Table of contents

• What is the price-to-earnings (P/E) ratio?
• What is a negative P/E ratio?
• Different types of P/E ratios
• Interpreting P/E ratios: High, low, and negative
• Significance of P/E ratio for mutual fund investors
• Limitations of the P/E ratio
• Beyond P/E: Other key metrics used by fund managers

What is the price-to-earnings (P/E) ratio?

The P/E ratio compares the market price of a share with the earnings generated per share.

In its simplest form: P/E ratio = Market price per share ÷ Earnings per share (EPS)

This formula is meaningful when a company reports positive earnings. When EPS turns negative, the resulting P/E ratio also becomes negative. Many data platforms therefore display the ratio as “not applicable”, as its interpretative value becomes limited.

What is a negative P/E ratio?

A negative P/E ratio occurs when a company reports negative earnings, meaning it has incurred a loss during the period used to calculate earnings per share (EPS). Since the P/E ratio is calculated by dividing the market price per share by EPS, a negative EPS results in a negative P/E value.

A negative P/E ratio does not necessarily mean that a company has no value or that its share price must fall. Instead, it indicates that the company is currently unprofitable. Such losses may arise due to temporary factors—such as cyclical downturns, higher costs, or one-time expenses—or due to more persistent structural challenges.

Because negative P/E ratios are not directly comparable across companies or sectors, investors and fund managers typically rely on other indicators to assess performance. These may include revenue trends, cash flows, balance sheet strength, debt levels, and the company’s ability to return to profitability over time.

In a nutshell, a negative P/E ratio highlights current unprofitability, not necessarily long-term weakness. It becomes a concern when losses are sustained and accompanied by weakening fundamentals, rather than temporary or explainable factors.

Different types of P/E ratios

• Trailing P/E ratio: Trailing P/E is based on earnings from the past twelve months. It relies on historical data and supports consistency in analysis. When those historical earnings are negative, the trailing P/E ratio also turns negative. In such cases, the ratio might primarily reflect the losses that occurred during the recent financial period, offering limited valuation insight on its own.

Past performance may or may not be sustained in future

• Forward P/E ratio and estimated earnings: Forward P/E uses estimated potential earnings for a future period. When the potential earnings projections indicate a return to potential profitability, forward P/E figures may be reviewed alongside other indicators, even if past earnings were negative.
• Cyclically adjusted P/E ratio (CAPE or Shiller P/E): CAPE calculates valuation using average, inflation-adjusted earnings over a longer period, typically 10 years. This approach helps reduce the influence of short-term earnings fluctuations and is often used for companies or sectors with pronounced earnings cycles. During temporary downturns, CAPE may provide a broader historical perspective, even when recent EPS figures are weak or negative.

Interpreting P/E ratios: High, low, and negative

The price-to-earnings (P/E) ratio is often used to understand how the market is valuing a company relative to its earnings. However, its interpretation depends on whether earnings are positive, low, or negative.

High P/E ratio

A relatively high P/E ratio suggests that investors are willing to pay more for each unit of current earnings. This may indicate expectations of stronger future growth, improving profitability, or higher business quality. At the same time, a high P/E can also imply that the stock is overvalued and more sensitive to disappointments if expected growth does not materialise.

Low P/E ratio

A relatively low P/E ratio may indicate that the stock is priced more conservatively compared to its earnings. This can sometimes reflect undervaluation, particularly if the business fundamentals remain stable. However, a low P/E may also signal market concerns about slower growth, earnings sustainability, or underlying business challenges.

Negative P/E ratio

When a company reports negative earnings, the P/E ratio becomes negative and loses its usefulness for comparison. In such cases, it is not meaningful to interpret the P/E as “high” or “low.” Instead, analysts and fund managers typically focus on other indicators—such as revenue trends, cost structures, cash flows, balance sheet strength, and industry conditions—to assess whether the earnings weakness is temporary or structural.

Key takeaway

P/E ratios reflect market expectations and perceptions, not certainty. High or low values must be interpreted in context, while negative P/E ratios require alternative analytical tools to understand business performance.

Significance of P/E ratio for mutual fund investors

For mutual fund investors, the P/E ratio may help provide context on how the market values the earnings of companies held within a fund’s portfolio. Fund managers may review valuation metrics along with earnings trends, competitive positioning, and broader sector conditions. The P/E ratio may help support analysis rather than offering potential conclusions. When portfolio-level P/E ratios turn negative, fund managers may shift attention toward other indicators that may better explain a company’s financial position and operating trajectory.

Limitations of the P/E ratio

While widely used, the P/E ratio has several limitations:

• It offers limited insight when earnings are negative.
• It does not account for cash flows, debt levels, or capital structure.
• It varies significantly across industries.
• It may appear distorted during periods of unusually weak or strong economic activity.

Beyond P/E: Other key metrics used by fund managers

Because of its narrow scope and limitations, fund managers and experienced investors generally use P/E ratio alongside other metrics for a more rounded picture. These may include:

• Valuation metrics: Measures such as the price-to-book (P/B) ratio and EV/EBITDA are used to assess how the market values a company relative to its balance sheet or operating performance, especially when earnings are volatile or negative.
• Profitability and capital efficiency metrics: Ratios such as ROE, ROCE, and ROIC help evaluate how efficiently a company generates returns from the capital invested in the business, offering insights into business quality and sustainability.
• Operating performance metrics: Indicators like EBITDA and operating margins are used to understand core business performance, cost structures, and pricing power, independent of financing or accounting effects.
• Cash flow and liquidity indicators: Free cash flow and operating cash flow trends help assess a company’s ability to generate cash and meet financial obligations, which is particularly important during periods of earnings stress.
• Growth and demand indicators: Revenue trends provide context on business momentum and help distinguish between temporary slowdowns and longer-term demand challenges.
• Sector-specific metrics: Depending on the industry, fund managers also track metrics specific to banking, manufacturing, or technology to capture nuances that broad ratios may miss.

Together, these indicators help fund managers assess whether weak earnings or reported losses reflect temporary pressures or more persistent structural challenges, enabling more informed investment decisions.

Frequently Asked Questions

What is considered a good P/E ratio in the Indian stock market?

There is no single benchmark for a “good” P/E ratio in the Indian stock market. P/E ratios are typically interpreted in relation to sector averages, a company’s own historical valuation range, and its growth prospects and business stability. What appears suitable in one sector may be considered expensive or risky in another.

How does the P/E ratio differ across various sectors like IT, banking, and manufacturing?

P/E ratios can vary widely across sectors due to differences in earnings patterns, growth potential, and capital requirements. Technology companies often display relatively higher P/E ratios, reflecting expectations of faster growth and scalable business models. Banking and financial services firms typically have P/E ratios that are influenced by factors such as interest rate cycles, asset quality, and regulatory conditions. Manufacturing companies may exhibit relatively lower P/E ratios, as earnings growth in these sectors is often more gradual and closely linked to economic cycles.

Can a company have a negative P/E ratio? What does that mean?

Yes. A company can have a negative P/E ratio when its earnings per share are negative, indicating that it has reported losses for the period under consideration. However, a negative P/E ratio does not explain the underlying reasons for those losses or indicate future performance. In such cases, investors typically look at other factors such as revenue trends, cash flows, balance sheet strength, and business conditions to assess the company’s prospects.

How can an average investor use the P/E ratio when selecting mutual funds?

Investors may review aggregate valuation metrics of a fund’s underlying holdings alongside diversification, risk profile, and earnings consistency, rather than relying on P/E alone.

What are the risks of solely relying on the P/E ratio for investment decisions?

Using the P/E ratio in isolation may overlook cash flows, leverage, business cycles, and earnings quality, especially when earnings are negative or unusually volatile.

Where can I find the P/E ratios of stocks and mutual fund portfolios?

The P/E ratios of individual stocks are widely available on stock exchange websites (such as NSE and BSE), company filings, and financial market platforms that provide stock data and analysis. For mutual funds, finance websites calculate and compile data on P/E ratios.