Price-To-Research And Development Ratio (PRR)

The PRR is only a useful measure for companies which engage, as a way of life, in a substantial amount of research and development expenditure every year. Companies in pharmaceuticals, electronics, bio-tech and computer software are typical examples. The PRR will, therefore, only
be shown in company entries where there has been research and development expenditure of over 1% of market capitalisation as shown by the latest Annual Report.

The PRR is obtained by dividing the market capitalisation of a company by the total research and development expenditure. This is the same as dividing the share price by the research and development expenditure per share. For example, if the market capitalisation of a company is £200m and the research and development expenditure is £5m, the PRR is 40.

The PRR provides a quick and easy check on the relative amounts being spent on research and development by different companies in the same sector. It is also helpful as an investment measure if a company is making losses and is in a valuation 'black hole'. On occasions, the PRR can provide startling evidence that such a significant amount is being spent on research and development that the shares ought to be a bargain, if and when the company recovers.

Examples include Kewill Systems, which had a very attractive PRR of 2 in January 1993, when the shares were 47p (end of 1993 -265p); Avesco had a PRR of 3 in January 1993, when the shares were only 15p (end of 1993 - 130p after a 1 for 3 rights issue at 63p); Kalamazoo had a PRR of 4 in early 1993, when the shares were 30p (end of 1993 - 100p).

Kenneth Fisher, in Superstocks, again writes at length about PRR's and believes them to be a very powerful measure for technology stocks, especially when used in conjunction with low PSRs.

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

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.

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