Why A Negative P/E Happens and What to Use Instead

0:00If you've ever pulled up a stock and you saw that the PE was negative, we'll say it was 47.8. And you're like, wait, is this cheap? Is it, is this bad? What, what, what's going on here? You're not alone. And a negative PE doesn't really work as a valuation tool because the company's in negative earnings. So today, Andrew and I are going to break down why a PE breaks, the main reasons it goes negative, and why you should use instead so you can evaluate an unprofitable company without guessing. So here we go. This show is sponsored by Liquid IV. Summer is here and let me tell you I could not be more excited.

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2:48Stephen:noise to focus on what works compounding discipline and the conviction to buy wonderful businesses and stick with them your path to financial freedom start now and welcome back to the investing for beginners podcast my name is steven morris and he is andrew say there he's back finally the long-awaited return and i know it doesn't seem like a long-awaited return for you guys because you know we thought ahead like andrew's about to have a baby so pre-recorded a bunch of stuff but for me it's been like four months without andrew um that's a lie it's only been a month and a few days but it's been a long month so i am so happy to have you back andrew my partner in crime i don't feel alone anymore if i start babbling if i start whining crying uh that's my excuse i mean it's a fair excuse because the cold intro took me like three tries because there's just all the rust haven't done this for a month but today we andrew we are going to talk about a pe and in the opening i mentioned a very specific pe because a while back we got a request um to to look into a a satellite company which i i was doing while you were gone And the very first thing I noticed, I went to fiscal and I scrolled all the way down and it's like, huh, negative 47.8 PE.

4:18That's not that solid. And so today I really want to dive into why a PE goes negative. And is that an automatic red flag? Like I get that it's a red flag. It's an automatic no-go. um or is it can can we look through the financials try to discern why it's negative maybe figure out what the story is and still maybe find a good investment in a company that has a negative p.e so are you ready yes okay here we go first question what is a p.e

4:56Stephen:oh you're really getting me the hard ones hey we're warming you up PE is short for price to earnings. You take the price, you divide it by the earnings, the earnings being the profits that a company generates. In the context of negative PE, we know that a price can't be negative unless you're oil in 2020. But as far as a stock, I don't know any stocks that are paying you to hold the stock. That would be a pretty sweet deal. So there's no negative price. So since we know there's only two metrics, One of them can't be negative. The other one has to be negative. So whenever you see a negative PE, it's always 100 % because of negative earnings.

5:37Stephen:I guess part of the trickiness is there can be different PEs depending on what website you're looking at. So in the context of you, I don't know if you were looking at a forward PE or a trailing PE, which fiscal has the two different ones and depending on which website you're on they might even call it different things so that can sometimes be something to watch out for as well so i i was looking at the forward p what's the difference between the two how would they affect you if you're looking at forward versus past yeah 100 so uh obviously like past is telling you what has happened forward is what everybody thinks is going to happen, the forward based on Wall Street estimates.

6:25Stephen:And if you've been following around Wall Street for a while, you will know just how squishy those estimates really are. So hopefully when you're looking at a forward PE, you're taking it more with a grain of salt. I know a lot of value investors, myself included for a long time, I liked to just ignore the forward PE. I guess I'll kind of come around to being like, okay, sometimes it can be useful. Um, but that's a lot of, um, quants, like the type of traders that go in and out of stocks based solely on formulas. And I'm sure there's AI agents doing this now, but a lot of them will most likely be using a trailing PE instead of a forward PE because those estimates are getting so squishy.

7:11No, that's totally fair. And I guess kind of the final question I have is, you know, the listeners have obviously heard me rant about my hatred for the PE because it's so freaking flexible. It just depends on the company. And the example I like to use is Ferrari because I think when we were looking at Ferraris was around 35. And for most companies, that is extremely high. But for Ferrari, that's pretty reasonable. and it frustrates me that that it's not a it's not a like i guess like hard like factual like this is the pe you want and you kind of got to get the the story and the evaluation all that stuff put together before you can determine if the pe is actually good or not and that's super frustrating to me so just real quick why why is that the case why why is why would a pe for google of 35 be bad and a pe for ferrari of 35 be good because we're all out here just trying to make

8:21Stephen:educated guesses all of us like an entire market an entire economy all the people who are all broad ranges of emotional and intelligent and all of those things so the crowd has decided that ferrari is a great company and it has had a high pe for a very long time why the crowd decides what it decides what the crowd will decide tomorrow those are all questions i wish i had the answer to um and it's just one of those things that's the madness or the wisdom of the crowds however you want to look at it. That's fair. That's totally fair. And so I guess when we're looking at the negative PE, there are three, I think there's probably more, but I think the most common reasons, first of all, will be obviously they have real operating loss.

9:18The business is generating profit, I'm sorry, is not generating profit from their day-to-day operations. And this could be from a lot of things. It could be their business models completely broken. It could be that they're in a bad cycle right now. So like the housing market, I think would be a good example of that. And is there anything else like, or I guess another one, Andrew, might be the way early stage startup um and they're just burning capital as fast as they can um is there anything of it

9:56Stephen:that i missed in that there's impairments which is very near and dear to me not near and dear that's not the right way to say it i it's it's something that's very vivid in my memory because i have a stock that just went through this so when uh i'm talking about crocs crocs i don't know how familiar people are with that brand that company uh they recently did an acquisition of hey dude which what is your opinion on those you think they're ugly or do you think they're i'm so freaking lootly dude you could not pay me to wear them no you don't have any love for the budget aspect of it it's like pound for pound maybe a decent quality compared to i don't know an overpriced nike or something no are we talking about crocs or hey dude hey dudes Yeah.

10:48Hey dude. Absolutely not. No. Okay. Crocs. Yes. I love Crocs. They are the ugliest God forsaken thing on this planet. Yeah. Um, but man, like they are more comfortable than anything I've ever wore in my life. And so, I mean, I, I love how comfortable they are, but I stopped wearing them one time because my wife took a picture of me wearing my Crocs. I was outside doing something and I had I was wearing shorts and I had socks on in my Crocs and she took a picture of me and she sent it to me and she's like you look so stupid and it's like you know what you're right I really do look stupid so my Crocs went in my closet and haven't come out since

11:35Stephen:what were you doing outside was it yard work yeah I was like picking up branches or something Yeah, that's funny. So anyway, so they overvalued HeyDude when they acquired HeyDude very recently. And then they realized after they had integrated HeyDude into their company that it was a big overpay. So they took a huge write down on that acquisition. And that is one of those situations where it drags on your earnings. It hits the earnings, but it doesn't hit the cash flow statement. So you get profit versus free cash flow disconnected. And that's where in that case, in that year that you're getting this big write down, it might not be a good indication of where the value of a business is.

12:28Stephen:We can also look at that on the flip side right now. very interesting is Amazon. I don't know how closely people follow. Obviously, everybody knows what it is and everybody seems to talk about it. Right now, they are the opposite of what Crocs is, where they have great profits, lots of profits, but they have negative free cash flow because they're doing so much CapEx, building all these data centers. and that has its own considerations as well. So you can see that sometimes, a lot of the time, free cash flow, net income, your DCF, the way you think of how much a stock should be worth, it all lines up nicely and neatly.

13:11Stephen:But other times, there's very specific situations where those numbers don't line up. And so you do need to know some of the nuance so you can figure out, how does this apply to the stock I'm looking at? Yeah. And I think that's a great example because, I mean, Amazon doesn't have a negative PE, I don't think, from that. But that could be a good example of a company that might have that negative PE. You look at it and you're like, holy crap, they're spending every ounce of their money to build these data centers or whatever it is that they're building to expand the business. And that is a very, in my opinion, that once you understand that, if you can get through the nuance of it all and actually see the vision, I guess, the company has, that would reassure me, I think, a lot to, maybe this still might be a good investment.

14:11Stephen:Yeah, absolutely. So just to recap, you know, the number one reason that you're going to see a negative PE is just real operating loss. And really the question you got to ask yourself when you're looking at that is, is the core of the business losing money or is it something else? And like Andrew just kind of went over, you really are going to have to dig into the company's story to figure out if that's the case. Reason number two, Andrew already covered on a little bit, are one-time charges or accounting noise And these are things like write-downs, restructuring impairments, legal settlements are a big one And earnings can really look awful and cash flow is really impacted in many different ways when you start to get these things so Andrew like as you were kind of talking about hey dude is how does crock write the ship now since they did overvalue hey dude it's become obvious that they overvalued it how are they going to write the ship and that will tell you as a shareholder like I'm going to either stay in this company or I'm getting rid of it as soon as I can I'm excited to share our friends over at the plink app release a major upgrade featuring a sleek new look real-time insights smoother trades and tools that help you feel more confident with every move.

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17:18Stephen:Send at least$5 to a friend in the first two weeks. Terms apply. Cash App is a financial services platform, not a bank. Banking services provided by Cash App's bank partners. Bitcoin services provided by Block Inc. brand. For additional information, see the Bitcoin disclosures at cash.app. What's the best way to get started in the market? Download my ebook for free at stockmarketpdf.com. Yeah, I guess you hope that they learned. This is one of those things. You see it's too late. The milk has been spilt. They've burned the cash. It's gone. and I guess how do you analyze whether they they've learned from that or not you can try to take cues from how they're responding to it what are they saying out loud what are their priorities how are they viewing it are they being transparent those are all ideas and ways you could try to analyze whether this is a one-time thing or if they're going to continue to make mistakes like this?

18:22Stephen:I wish I had like a very solid answer for it. But I really think you look at the business, you look at the management, do you still believe in the core strengths of the business? Do you still believe in the competence of the management? Did they just make a mistake? Or are they fundamentally making these mistakes all the time? Obviously, we know where I stand, I still own the stock, but every, every, yeah, every, every, uh, every situation can be different. Well, and I think that that's, that's actually a really huge insight because, you know, a lot of, um, the louder will say politely, uh, gurus of the stock market, the, they like to scream and rant and, you know, tell you how bad of a company it is.

19:17When reality, a company is a machine for, you know, lack of a better term, but that machine is ran by people. And while a machine can be, you know, as perfect as you can possibly get it, humans cannot. Humans are going to make mistakes. And, you know, Kroc made a mistake. It's a very obvious mistake. And I remember when they did it, you were concerned about it. It was something you talked about very openly that it was a big concern for you. And so, I mean, when we're looking at this, I guess the main question I have to ask myself is, do I believe this is a one time occurrence or are they showing up reoccurring pattern of making stupid decisions, making bad decisions?

20:08Were they just human for a second or is their machine completely broken? So that pretty much wraps up the one time charges. Before we move on, though, Andrew, just a little bit of what's what what is it? In elementary school English, you had your spelling words and your vocabulary words. So let's just hit some of these vocabulary words write downs. What is a write down?

20:39Stephen:Yeah, they're taking a loss on something. They have some sort of asset that is no longer what they paid for it. This could be inventory. This could be an acquisition. Any of those things. And then obviously restructuring is something going on with the core structure of the business. The one we've recently talked about is Allbirds. Have you heard anything about Allbirds and their AI ventures? since the initial thing or was that a hoax or i've not i i heard something just randomly i don't even know what i was listening to they were saying that like they were trying to say that the people who work in the ai industry like their shoes and that was part of this justification but it doesn't that doesn't clear that doesn't clear in my book like they're still guilty as charged to me i mean yeah didn't their stock like 10x and just a few few hours or something i don't know or six x it was huge it was a huge growth uh from what the whole issue uh we already covered impairments and what those are uh just kind of making a bad acquisition um and then obviously legal settlements um and then that can be that can be huge because a company a large company gets sued every day all day legal settlements is something uh at least in my mind i watch very closely because that can very quickly uh turn a company upside down if you're not careful yeah i think these and mastercard are still working through something that was 10 15 years ago every year in their annual report they're mentioning it and yeah that's uh it's good to look at yeah Spotify is another one um dealing with and I think that's just kind of the the model of what Spotify is um but they're constantly having to deal with uh is it copyright I'm not sure what what type of law that would be but just where where musicians and Spotify are disagreeing on ownership or i guess of the the music but um yeah spotify is another one that they spend a lot of money in court or settling so just something to be aware of that you got to wash out watch out for moving on i would say the the third and final main reason you're going to see a negative pe are heavy reinvestments.

23:17Or like I mentioned earlier, they're very early and they're trying to rapidly grow. If a company is intentionally spending money to grow, they're going like, you know, Amazon was a great example of that. I think they're popping up data centers all over the place. And, you know, we talked about cat, you know, like 10 episodes ago, like 10 billion of cat's revenue is just from data center work data center work and i mean that's insane obviously not all that's from amazon but still and then uh you know another thing you got to consider losses can be strategic um but even if the loss is strategic it's still very very risky

24:08Stephen:Yeah, it's outside of my circle of confidence, this whole like hyper growth kind of story. But the idea and tech has really amplified it. But the idea is that if there's a market where there's only going to be a few winners, and there'll be winner take all or winner take, how do they say a few take winner? I can't remember how you say it. But if that's how it's going to play out and how everybody thinks this industry will play out, then profit is not the priority because you got to get to scale and you got to be there first. And I think you're seeing that with AI companies today, Anthropic, OpenAI, they're believing cash, they are deep, deeply in the red is because they want to be those solid number one, two, three players and any other competing AI models be not near the kind of quality and market share that these companies have.

25:04Stephen:So that's why you'll see it. I mean, they almost have to, I would say. Obviously, it's way out of my circle of competence as well. But just, I guess, logically thinking, you know, OpenAI, they have to be spending this cash because they take a day off and they're left in the stone age because it's evolving so rapidly. I mean look at what three years four years is all it's been really because I mean think about 2020 I mean AI was around but it wasn't like opens like you can like open AI didn't exist at least not in the form it does today like you know I started college in 2021 and I had no filter that I had to run all my papers through to prove that it wasn't AI generated like I did when I graduated.

26:08Like, I mean, just in that short amount of time, AI has exploded. And I feel like if open AI, Google, like if these companies aren't dumping this cash into their AI, it's it's they're going to get left in the stone age and ultimately lose out because i don't think once you get left behind it's going to be really hard to catch up yeah it's a crazy crazy world yeah i mean how fast it's involved evolving it blows my mind um but are you buying into apple

26:41Stephen:ai's hype are you talking about the mac mini thing or are you talking about the new siri thing the the new updated siri uh that they're coming out with i haven't even seen it i know they've released it oh did they release it already i mean like they announced it right oh okay the conference thing but uh i haven't looked into it and i'm skeptical because i've never been a fan of it even today like using the apple intelligence and just asking a simple thing drives me nuts because they just give you the answer and then there's nothing else you can do versus if you go on Google and use your microphone and then it gives you the Gemini and then you have all these options to keep going down further.

27:23So I don't know that I don't know how you feel about their

27:27Stephen:Apple intelligence and the AI, but it, it, it kind of irritates me. It sucks. Like, yeah, it's horrible. Um, and I think the, the world at large agrees with us, the Apple intelligence is straight garbage. Hold on. One last thing. This is a negative company. So I'm going to say that it's relevant did you see snapchat's new ar glasses i did not okay look it up it um they are big they are boxy uh and the ceo was was wearing them everybody's kind of giving them crap about it because they're like first off the the the glasses kind of like the vision pros or or the Meta Glasses, right? They're$2 ,200 for a pair.

28:14Stephen:And again, they're just these huge bulky things that are sticking out of your head. And people are saying, the Snapchat demographic and a$2 ,200 price point, something here is not adding up. And apparently they had spent like$2.000.000 billion amount for a small company of their size and they have negative earnings now. This could have been a profitable company if they didn't go down this rabbit hole with these glasses. And people are saying, I saw like a meme was like, what kind of culture doesn't tell the CEO? And they're like, hey, this was a bad idea. Like, let's not spend$2 billion on like, it looked like, you remember the GameCubes?

28:57Stephen:Yeah. I'm exaggerating a little bit, but like put like two GameCubes on your face. His ears could barely hold the glasses. That's got to be so uncomfortable. I've never actually wore those, like the meta goggles or anything like that. But just looking at it, it looks super uncomfortable. And speaking of Snapchat, that's another company we were talking about legal issues. That's another company that had really heavy legal issues for a long time. So, yeah, yeah, these are the things we got to think about. And I guess the main question you have to ask when you're looking at this is, are they buying growth efficiently?

29:39So Amazon, great example of buying growth efficiently. Or are they just burning cash? And I think, I mean, I'm not a psychic. I don't want to predict the future. But I can't imagine these AR goggles being a gangbuster for Snapchat. I really can't. Sorry.

30:00Stephen:Yeah. Yeah, you're really giving us the hard takes today. Fair enough. So, Andrew, what can we use instead if we look at a company and it has a negative PE and we're like, well, that takes away the DCF and all that stuff. Like what tools can we use instead of a PE? I've been thinking a lot about heart health lately. Not because something felt wrong, but because I got my results back and saw markers I'd never even heard of that were out of range. What caught me off guard is how much can be happening quietly with markers most people have never even had tested. Here's the thing about feeling healthy.

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