Something amusing, or rather, shocking was revealed when we decided to check on a fact Jim Grant noted yesterday in the fine print of the iShares Biotech ETF, also known as the IBB.
As a reminder, this is an ETF whose price over the past two years had gone absolutely parabolic and which almost doubled in the past year until the recent tremors managed to put a slight dent in the second tech/story bubble.
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So say one is suddenly concerned about the valuation of the ETF and decided to check what the P/E multiple of the underlying biotech basket. One can simply pull the iShares IBB fact sheet [5]where one would find the following...
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Ok so, 41x P/E: not exactly cheap but hardly the ridiculous bubble valuations one is used to from the first dotcom bubble, right? Wrong. Because if one reads just a little further down the page one finds the following shocking disclaimer:
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Here is what the highlighted section says:
Negative earnings are excluded, extraordinary items are excluded, and P/E ratios over 60 are set to 60.
What? So basically the "reported" PE is one which just happens to exclude all companies with negative earnings, and also rounds down any biotech company with a PE higher than 60x to... 60x.
Here alarm bells should be going off, because clearly the whole purpose of this latest "fudge" is to make the ETF appear more palatable then it is, when in reality the actual PE of the companies is something vastly different.
Haw vastly? We decided to break down the components of the IBB using Bloomberg financial data, and found the following stunners:
- Of the 122 companies that make up the basket, only 25 have an LTM P/E multiple that is under 60X (and above 0.0x)
- What is worse, of the entire IBB company universe, a whopping 86 companies have negative net income, which according to the definition are simply excluded from the calculation!
In other words, 80% of the companies that make up the IBB are either "adjusted" or outright excluded from P/E calculation purposes.
So what happens when one adds across the market caps of the constituent companies and divides by their consolidated earnings, and yes including those companies that have negative earnings.
The result is shown below.
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Or reported PE 40.9x, real PE: 82.5x. Just a slight difference.
Bottom line: the reported P/E of the IBB index is more than 50% lower what it really is!
Of course, in this current market bubble, we doubt anyone would care much if at all about fundamentals, as the only games in town are i) excess liquidity, ii) momentum and iii) finding a greater fool to sell to before the bubble really bursts and things like P/E multiples and generally fundamentals are again relevant.
It appears this fact was NOT well known...
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