What is price-growth flow?

Price-growth flow is a financial ratio that identifies whether a company’s investment in research and development (R&D) is converting to earnings. 

Below, we explore what price-growth flow means and learn how to calculate the price-growth flow ratio of a company.

Companies around the world spend hundreds of billions of dollars in innovation and R&D expenses in order to remain a step ahead of competition and to save themselves from technological obsolescence.

However, not every company is successful in converting R&D into revenue. For pharmaceutical and healthcare industries, innovation can be a tricky path as discovery of new drugs could take several years and are subject to clinical trials and government regulations. In the meantime, tech companies may see their R&D activities wasted due to the fast-paced and competitive nature of the market.

Stock market analysts look at metrics like the price-growth flow to get a clearer picture of how efficiently a company is deploying its R&D capital.

Price-growth flow explained

A high price-growth flow ratio for a company could indicate that the firm is likely to profit off its R&D efforts. A low price-growth flow ratio could indicate that the company is either not allocating enough to R&D expenses or that the share price is not reflective of future gains from such expenses. 

A survey of 1,500 executives conducted by Boston Consulting Group (BCG) in 2021 showed that 75% of them marked “innovation” among the top three priorities at their companies.

However, BCG reported that only about 20% of companies are ready to “scale innovation” based on BCG’s framework to measure “readiness of their innovation programs to operate at a consistently high level of efficiency and effectiveness”.

How to calculate price growth flow?

Learning the price-growth flow formula could help traders and investors understand the price-growth flow definition better.

You can find earnings per share (EPS) and R&D expenses data in quarterly and annual earnings reports, usually published on the company’s website. The share price and the number of outstanding shares of a company could be also found on the official company’s website and on the exchange, where its stock is listed. 

Dividing the R&D expense by the number of outstanding shares will give you the required metric needed in the formula above.

Understanding price-growth flow

According to data firm statista, e-commerce pioneer Amazon (AMZN) was the biggest R&D spender in the world in 2020. The company spent a whopping $43bn in R&D investment during the year, representing about 11% of its annual revenue. 

Google-parent Alphabet (GOOGL), Chinese telecom equipment manufacturer Huawei, software company Microsoft (MSFT), iPhone maker Apple (AAPL) and South Korean tech conglomerate Samsung (SMSN) were also in the list of the top five R&D spenders in 2020. It may come as no surprise that the biggest spenders in innovation were technology firms. Other industries that are known to make big R&D investments are healthcare and automobiles. 

It is important to remember that price-growth flow ratio does not tell the full story about effective capital management. Investors must be aware that risk of technological obsolescence and competition can result in futile R&D efforts from companies. High R&D allocation does not guarantee profits.

Market share price is an important determinant factor when calculating price-growth flow ratio. Stock prices can be driven by multiple factors other than company fundamentals or growth potential. Political and economic macro environments also have significant influence on stock markets.

Price-growth flow ratio could be used alongside other financial metrics to get a wider view of a company’s performance and future growth potential.