What does negative EPS tell us about a company?

What is negative EPS?

Negative EPS means the company is losing money. This is profound because companies exist for one reason: to make money and distribute that money to their shareholders. Since for-profit companies rarely decide to become non-profits, negative earnings (or EPS) usually imply something unfortunate is going on. I’ll look at what this usually entails for your money losing investment.

We make a distinction between negative EPS and transient negative EPS. I’m clarifying this because there are three intervals people talk about income over:

  1. Annual Income — This is the income reported on the 10-K. It covers the year being reported on in the annual report at the SEC.
  2. Quarterly Income — This is the quarterly income reported to the SEC four times a year. Sometimes the annual report will also contain that quarter’s report, but Morningstar sorts this out so the data you get won’t have to worry about that.
  3. Trailing Twelve Months Income — This is simply the sum of the last four quarterly incomes. This can be different from the annual report because you might be a quarter or two or three from the last annual report.

Thus, one, two, or all three of these can be negative. If one or two are negative, we have transitory negative EPS. If all three are negative, we have negative EPS. As you will see, negative EPS can be a harbinger of future financial displeasure. Transitory negative EPS is a much weaker signal. To summarize:

Transitory Negative EPS, which refers to a company with negative EPS in any one or two of the quarterly, the annual, or the sum of the last four quarterly reports.

Negative EPS, which refers to a company with negative EPS in all three of the quarterly, the annual, and the sum of the last four quarterly reports.

Why do some stocks have negative EPS?

Negative EPS could happen because of any number of reasons. Here are some common ones.

  • Increased expenses
  • Accrued income never arriving, for example, if the company that bought the services can’t pay or goes out of business
  • Investments that haven’t generated expected returns
  • Declining sales
  • One-time write-offs, such as when a company buys another, and decides that it wasn’t worth as much as it paid
  • Assets that are no longer producing returns
  • Too many competitors

I could write a articles about most of these reasons (probably will at some point), but the why is not the focus of this article. The consequences, instead, are what I’m covering here.

Is negative EPS always a bad sign?

Generally, non-transitory negative EPS is a very bad sign. We have an article that details how I decided that negative EPS is a black flag. It details my attempts to make a profitable screen using only companies with negative EPS, excluding a wide variety of odd situations. As you can read, it was quite difficult to create an outperforming screen, and the result had too much drawdown. Unless you are willing to go to the sort of effort detailed in that article, you probably want to avoid normal companies with negative EPS.

If you scroll down here, you can see how by contrast, transient negative EPS is less daunting. It is still not ideal, because of the volatility, but can be dealt with.

How does negative EPS affect a company’s stock price?

Negative EPS in normal companies is bad news: the returns since 2000 were negative. The maximum drawdown is also higher: 75% vs the normal 55%. Also, as detailed in our black flag article, it is very difficult to make a good screen with negative EPS.

Notice that the chart is down and to the left!

What about negative EPS in the S&P 500?

At first I thought that was a trick question: The S&P 500 inclusion criteria mandates positive earnings for the last four quarters. But I tested it anyway, and lo and behold, companies matched. My guess is that they take time to get dropped. Investing in them is still not a great idea, especially compared to the rest of the S&P 500.

Close on Jan 3, 2000 to Apr 4, 2024Returns S&P 500 
Total Returns34.62%446.9%
Drawdown87.3%55.2%
Annualized Returns1.23%7.26%
Daily Beta1.435
Annualized Alpha-8.35%
Being part of the S&P 500 isn’t enough to make Negative EPS a joke

The returns are ugly, with okayish returns many years, and awful returns the others. 2003 and 2009 are the exceptions, with great returns, just to prove that that all rules have exceptions.

What about negative EPS with good momentum?

I wanted to know which is more important: momentum or negative EPS?

ScoreMin Pct Qtr Gainnum matches
-1.03%0111.65
-21.17%886.25
-21.23%498.3
-43.74%1275.55
-50.99%1664.25
-68.76%2055
-73.33%2447.8
-78.42%2841
-81.06%3235.75
-90.77%3631.05
-93.51%4027
Momentum is positively correlated with financial pain

Does investing in negative EPS companies with bad momentum work?

Is negative momentum and negative EPS a less ghastly combination than positive momentum and negative EPS? Maybe they go hand in hand to profits. Nope! It seems they both prefer losses.

ScoreMin Pct Qtr Lossnum matches
-78.74%088.95
-78.98%-478.3
-88.62%-866.7
-94.28%-1255.45
-96.64%-1646.75
-97.73%-2038.6
-98.28%-2431.05
-98.64%-2825.45
-98.18%-3219.8
-98.95%-3615.65
-98.16%-4012.2
Halloween is negative momentum combined with negative EPS

Can Piotroski F-Score help us when investing in negative EPS stocks?

The idea here is that companies with stronger financials can survive losing money. It turns out they can, as higher results are better. Since one point is denied them because of their money loss, the max achievable score is 8, but higher is in general better.

ScoreThe Piotroski Scorenum matches
-96.65%00.45
-99.58%16.55
-71.74%223.95
-65.21%343.9
20.3%453.65
1.45%543
5.79%622.35
2,666%76.35
23.7%80.3
0%90
High Piotroski scores for the better results even with negative EPS

If the Piotroski score is below 4, it will make you poor.

What about companies with transient negative EPS?

So the question here is what if only the yearly statement has negative EPS? Or just one quarter? Or just the trailing twelve months? The black flag refers to all three being negative. What if it’s not all three, but one or two of them?

As it turns out, that is not nearly as bad.

It still has the terrible drawdown, but much better performance.

What should an investor consider when evaluating negative EPS stocks?

The investor should ask:

  • Do I feel lucky today? Really lucky?
  • Do I know something game-changing about the stock that nobody else does?
  • Do I have the time, willingness, and conviction to create an intricate, slightly unreasonable portfolio quantitatively, and use that?

If the answer to all three questions is no, the investor should look elsewhere.