Earnings Yield - Reading 42 companies, presented, therefore

maratikus

The answer to question 2B on p.558 of Equity CFAI text rates Hand over Somersault. Both have negative earnings, so E/P is used (P/E would be meaningless).
Hand’s earnings were -$2.20 and the price is $22.
Somersault’s earnings were -$1.25 and the price is $10.
Hand’s E/P is therefore -.1; Somersault’s -.125.
The rationale is that Hand has the higher E/P, so it is the better share.
In the absence of any other information, when you are presented with two companies - one losing $2.20 and another losing $1.25 - which would you pick? I would go for the smaller loser.
In fact, I wouldn’t pick, because the information is obviously insufficient.
Negative earnings give meaningless P/Es, but are their E/P’s any more helpful?
Put another way, Hand’s E/P would go from -.1 to -.01 if its price were $100 instead of $10. -.01 is a higher number than -.1, so that would make it a better buy at ten times the price!
What am I missing here? I just don’t get this…

jbaldyga

would you rather buy a stock that is losing 10% of its value or the one losing 12.5% of its value.

JGovender

Thanks, kurupt1, now I feel stupid! Anyway, v nicely & succinctly put.

kim226

can someone explain the concept of E/P? i get that negative p/e is meaningless. so the theory is you invery it to get e/p and look for the largest ratio to be the best. fine but any negative number inverted is still a negative #. am i missing something?

chunty

negative E/P can still be ranked.
-0.125
you would be able to rank the companies - even if they had negative earnings.
selecting the company with 20 - is a good choice in the list above.

lc26mizzou

so E/P still retains the negatives in the ratio, but the difference is that you can use them for purposes of relative comparison (to other negative and also to positive E/Ps)?

hariRaj

It all seemed so clear when I first read kurupt1’s post, but either I’ve taken a step backwards or the explanation doesn’t quite work.
It is true that you would prefer the company which is shedding the smaller percentage of its value, as you would one yielding the larger. However, aren’t we confusing price with value here?
If price equals value (i.e. markets are perfectly efficient) then ranking stocks is anyway futile, because lower E/Ps will be more “expensive”, but deservedly so.
If price does not necessarily equal value (which has to be the assumption when we’re ranking stocks in this way), we cannot weigh the earnings against the price/value in this way.
A positive earnings yield is informative, because in the absence of other information and all things being equal, we elect the stock with the higher return.
A negative earnings yield is not informative, because were it to persist, the company would be worthless. In the absence of other information, and all things being equal we should pay less (if at all) per share for any losing company (no matter the size of the loss).
Were we to compare earnings to a more meaningul metric, such as book value, then it would make sense to rank negative yields in this way - we could say the company is worth x, and it’s rate of depletion is therefore y/x - choose the slowest depletion rate in the hope of a timely turnaround.
Unfortunately, because price cannot be assumed meaningfully to equal value in this case, justifying a price by assuming it represents an objective value is circular.
As far as I can see there is no meaningful symmetry between positive and negative E/Ps. The going concern assumption (i.e. persistence of earnings, approximated by the current figure) cannot hold in a negative situation.

ayodayo

i think the idea of E/P is not to go into the entire whole analysis you did above. But the simple thought process is as follows:
If you had 3 companies you were comparing, all with negative P/E - and you wanted to invest in 1 of them, definitely - which one would you choose?
When you are comparing positive P/E companies - lower is better…. relatively.
but when you have a company with a negative earnings - it is lower than the +ve numbers - so is lower better still? or would you just pass on the opportunity of investment in the company because it had negative earnings which might be due to temporary effects - and miss out on the investment opp?
Go one step further - and all your companies you are analysing had negative earnings - and that’s all your investment universe was…

Matori

lmb, you invest based on a cash amount not a number of shares…
i have ￡500 to invest, not i am going to buy 500 shares of