Calculating P/E ratio with negative EPS
Hi WSO,
I'm in need of some accounting/financial advice. If I'm calculating the P/E ratio for a series of pre-revenue biotechs and many of them have a negative EPS, can it still be done?
I would end up with a negative P/E ratio which I know is not great, but if all of the companies analysed result in negative P/E ratios can I still make comparisons?
The underlying theme is to understand if companies with certain characteristics are over or under valued on the stock market. Would also be happy to hear thoughts on using ratios other than P/E. Am also considering Earnings Yield and P/E - Growth ratios.
Cheers
Why don't you look for another measure?
For negative EPS, you can use Enterprise Value to EBITDA or EV/Sales to come up with a number which can then be compared with the market stock price to figure whether it's over or undervalued.
Maybe you can use a forward multiple with positive earnings projections?
Also perhaps in this case it might be best to value the company through a different approach like EV/Revenue, EV/EBIT, or even something like a precedent transaction analysis for a ceiling and an asset cost approach for a floor?
Negative ratios are useless. When the companies get closer to break even, the multiple get more negative and when it switches to positive it suddenly becomes a high positive number: no predictive value.
For pre-revenue biotechs you should value the pipeline, basically a DCF with probability of succesful tests/approval/etc. often with an exit to large strategic after that phase.
Thanks for the advice. I think what whatsapitchbook and investlikenewton makes a lot of sense and I should try those/other ratios. To provide a bit more colour to the analysis, the objective is to see if a binary categorisation (having assets with orphan designation/priority review/breakthrough designation) leads to an overvaluation of the stock. What I would want to do is find 2 ratios and regress then with OLS against the binary dummy variables and conduct a subsequent analysis to see if the different is statistically significant. Any insight on what to use with this approach or does the previous advice still apply?
You absolutely lost me after binary categorization
Essentially the question is: "Are companies with pipeline assets that have Priority Review/Orphan Designation/Breakthrough Therapy overvalued compared to those that don't?" I would compare overvaluation ratios of both types of companies and see if there is a statistically significant difference. My query is, what ratios are best for this analysis?
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