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-Research Ratio

What it is:

The price-to-research ratio is used to evaluate the price of a company's stock as compared to its ability to generate future profits from new products.

How it works (Example):

The formula for the price-to-research ratio is:

Price-to-Research Ratio = Market Capitalization / R&D Expense

For example, let's assume that Company XYZ spent $5,000,000 on R&D last year. It has 10,000,000 shares outstanding trading at $5. Using the formula above, Company XYZ 's price-to-research ratio is:

Price-to-Research Ratio = (10,000,000 x $5) / $5,000,000 = 10

Why it Matters:

The price-to-research ratio is one way to evaluate a company's ability to generate future profits. After all, R&D is a manifestation of a firm's commitment to innovation. Thus, the lower the ratio (that is, the higher the denominator) the more a company's "value" is tied to innovative activities.

It is important to note, however, that R&D spending is not a guarantee that future profits from that R&D will ever materialize. Nevertheless, the price-to-research ratio can provide insight into companies that compete within the same industry, because R&D intensity can vary widely. Thus, the definition of a "high" or "low" ratio should be made within this context.