be on guard against artificially low pe ratios that make both mid and smallcap stocks appear to be more undervalued than they are consider the russell 2000 index rut  perhaps the most widely used benchmark for the performance of the mid and smallcap sectors according to data from birinyi associates published in the wall street journal this index’s trailing pe was 5057 as of june 3 that suggests that the sectors this index represents are significantly overvalued yet according to ishares the index’s trailing pe ratio is 1345 which would suggest substantial undervaluation how can two reputable sources reach such widely divergent conclusions the answer traces to how they deal with unprofitable companies the ishares calculation ignores them while the wall street journal’s data source does not this makes a big difference when companies are losing money which currently is the case for many russell 2000 constituents no fewer than 43 of its constituent companies lost money over their most recently reported 12month periods according to my calculations based on factset data i should stress that ishares does not hide that its calculations ignore unprofitable companies it plainly states on its website for the ishares russell 2000 etf iwm that “negative pe ratios are excluded” when calculating the etf’s average pe nevertheless a more complete picture of the index’s valuation requires taking these unprofitable companies into account to be sure such an accounting involves a few additional steps one needs to add up the total eps of each component company whether profitable or unprofitable weighting it according to the stock’s weight in the overall index that total then becomes the denominator of the index’s pe ratio read smallcap growth stocks are the cheapest they’ve been in at least 24 years here’s how one manager is playing it the failure to include unprofitable companies doesn’t make such a big difference when almost all of the companies in an index are profitable that’s the case currently with the largecap sp 500 index spx  for example just 44 of its constituent companies lost money in their most recentlyreported 12 month periods moreover most of these unprofitable companies have relatively smaller marketcaps and therefore represent a tiny portion of the overall index i calculate that the failure to take these unprofitable companies into account causes the sp 500’s pe ratio to be just 33 lower than it would be otherwise that is a lot less significant than in the case of the russell 2000 the bottom line we get a false picture of the mid and smallcap sectors by ignoring the nearly half of russell 2000 stocks that lost money over the past 12 months while it’s still possible that these sectors will produce handsome returns in coming months bullish investors will need to support that possibility on something other than the russell 2000’s trailing 12month pe ratio mark hulbert is a regular contributor to marketwatch his hulbert ratings tracks investment newsletters that pay a flat fee to be audited he can be reached at markhulbertratingscom more cheer up stock investors us consumers are feeling down about their money and inflation plus here’s the littleknown reason why cathie wood’s ark innovation etf is having such a bad year