Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Price-to-Innovation-Adjusted Earnings Ratio

What it is:

The price-to-innovation-adjusted earnings ratio is used to evaluate the price of a company's stock as compared to its earnings when adjusted for the amount the company spends on R&D.

How it works (Example):

The formula for price-to-innovation-adjusted earnings is:

Price-to-Innovation-Adjusted Earnings = Price per share / (EPS + R&D per share)

For example, let's assume that Company XYZ, a company that designs and manufactures medical devices, earned $10,000,000 in profits last year. One of its big expenses was R&D, on which it spent $8,000,000 last year. Company XYZ's 11,000,000 outstanding shares currently trade at $5 per share.

Using this information, we can calculate that Company XYZ's earnings per share (EPS) equals $10,000,000 / 11,000,000 = $0.91. We can also determine that Company XYZ spent $8,000,000 / 11,000,000 = $0.73 per share on R&D.

Using the formula above, we can therefore calculate that Company XYZ's price-to-innovation-adjusted earnings is:

$5 / ($0.91+$0.73) = 3.05

Why it Matters:

Unlike the P/E ratio, the price-to-innovation-adjusted earnings ratio gives investors an idea of how well companies perform absent the expense of innovation. By adding back R&D expenses, the ratio removes the pressures and effects (some would even say penalties) of having to expense R&D costs for which a company may have little to show now but might reap huge benefits from later. In turn, the price-to-innovation-adjusted earnings ratio allows investors and analysts to identify more easily companies that are investing in innovation.