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What is the Price-to-Innovation-Adjusted Earnings Ratio?

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 Does the Price-to-Innovation-Adjusted Earnings Ratio Work?

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 Does the Price-to-Innovation-Adjusted Earnings Ratio Matter?

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.

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Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.