Basics to Researching Stocks : R&D/Net Sales Ratio

There are many metrics investors may evaluate to help determine which stocks to buy. One metric I use to evaluate a company before investing is the R&D/Net sales ratio. This ratio measures how much a company spends on R&D expenditures relative to its total net sales.

This metric is most useful when comparing companies to its competitors in their own industries. Comparing companies in different industries such as industrial’s to tech or pharmaceuticals, may not provide a good comparison because the R&D spending requirements may be different to keep competitive in different industries. The nature of the businesses and pace of the innovation curve itself will vary drastically between industry to industry.

Companies that maintain a healthy level of R&D spending is more likely seen to result in better competitive edge against its competitors than those who don’t keep up with the spending.

This metric helps provide some measure of assurance to investors that the company is forward looking.

Being a long-term investor, it’s important to know that the company continuously and religiously reinvest and strive to innovate. Lack of innovations may result to cancerous degradation in company revenues and profits overtime.

A company that maintains a steady or rising R&D/Net sales ratio reassures investors that the company understands the importance of innovation.

However, it is important to understand that R&D spending does not always equate to more profits or strong stock performance.

Here is a quick comparison on 3M and some of its competitors which helps investors get a different perspective on how aggressive each company strives to innovate compared to its peers.

So, R&D expenditures may potentially result in higher probability to innovate. It’s important to understand no single metric tells the whole story.