Negative earnings means losses. Most small investors should stay far away from companies with negative earnings. However, there are instances of even well-managed companies running into problems and making losses. If the problems are temporary in nature, then a turnaround may be just a few quarters away, and the stocks of such companies can give phenomenal returns.
But how does one know whether negative earnings have been caused by temporary problems, or whether the problems are more deep-rooted? Traditional valuation metrics, like P/E (or E/P) or RoE won’t work because the ratios will be negative. In a recent article at investopedia.com, three methods of valuing companies with negative earnings have been discussed.
Here is an excerpt:
“Investing in unprofitable companies is generally a high-risk, high-reward proposition, but one that many investors seem willing to make. For them, the possibility of stumbling upon a small biotech with a potential blockbuster drug, or a junior miner that makes a major mineral discovery, makes the risk well worth taking.
While hundreds of publicly traded companies report losses quarter after quarter, a handful of them may go on to attain great success and become household names. The trick, of course, is identifying which of these firms will succeed in making the leap to profitability and blue-chip status.”
You can read the full article at the link below: