By Brendan Conway
The selloff in the biotechnology sector brings an arcane subject out into the open. How do you assign a price-to-earnings ratio to companies which have no earnings?
Besides highly profitable firms like Gilead Sciences (GILD) and Celgene (CELG), a bevy of biotech stocks are priced for a future of high sales and strong earnings — a future which is, well, still not here yet. In a look at the subject today, ETF.com’s Paul Britt notes that the answer to the P/E question depends on details buried in your data provider’s methodologies.
It’s one of those cases where the details matter hugely — and could influence how investors perceive the value (or richness) of the investment they’re getting.
For instance: Britt notes that BlackRock (BLK), the issuer of the sector’s big ETF, iShares Nasdaq Biotechnology ETF (IBB), makes the defensible choice of omitting the sector’s loss-makers from the P/E equation, such that it arrives at a P/E of nearly 41. That will strike most readers as rich. But what if I told you the P/E is really negative 209?
That’s the view of Britt’s employer, which, unlike iShares, keeps the negative earners in the equation. The result is a net negative number. (Biotech, on the whole, is a slightly loss-making sector on a net basis, according to ETF.com’s calculations.)
Small net losses, like what is seen in the case of biotech, result in large negative numbers. Small net profits result in large positive numbers. The first means the group is almost at breakeven; the latter may put you on the road to judging that an investment is grossly overpriced.
There are other figures still floating out there. Bloomberg, Britt notes, displays “–” for the same ETF on its terminal. Morningstar assigns it a 25, using a method which, like iShares, throws out the money-losers.
Normally, this subject doesn’t matter, as profitable companies predominate in broad swaths of the market. But biotech is a niche where investors price stocks on hopes the future. So what’s the takeaway? Britt has it right:
When negative P/Es do show, they throw up a flag to investors, but beyond that, they’re hard to compare with each other.
Conversely, a method that uses reasonable rules and discloses them clearly—as BlackRock does—makes the numbers comparable, but could trip up casual or hurried investors by strongly implying a too-rosy earnings picture.
Bottom line: Investors need to understand what goes into their P/E number—as simple and familiar as it sounds—for the different sources they use.