Price-To-Research Ratio - PRR

Categories: Company Valuation

Lollapashoesa, Inc., premier retailer of fine footwear and foot accessories, has embarked on its biggest R&D project yet. Its goal is to create a fashionable high heel that won’t hurt the feet, even after a 10-hour workday or a night spent cutting a rug at our second cousin’s wedding. It’s an ambitious goal, to be sure, and Lollapashoesa figures they’ve spent about $25 million on their research and development efforts. That’s a lotta dough. But if they can pull this off, they estimate they’ll be able to bring in an extra $100 million in shoe sales over the next three years, which is even more dough.

But do the financial experts think this venture is worth it? To answer that question, we’ll need to figure out Lollapashoesa’s “price-to-research ratio,” or PRR. Ready for some math? We are too, so here goes. We calculate a company’s PRR by dividing their market capitalization (MC) by their R&D expenditures over the last 12 months (RD). Let’s say Lollapashoesa’s market cap is $230 million, which gives us:

MC/RD = 230,000,000/25,000,000 = 9.2

9.2 is right in the PRR sweet spot, according to Kenneth Fisher, the dude who invented this metric. Companies with a PRR between five and ten are, he says, redirecting a good portion of their cash back into R&D, which bodes well for future earnings. Therefore, they might be a good investment choice. Will this always be true? Not if the company in question is investing all its R&D cash in a venture that will never sell. But in the case of Lollapashoesa and the miracle stiletto, we’re willing to bet their investment—and our investment in their organization—will pay off in spades.

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Finance: What is the Price-To-Earnings R...217 Views

00:00

Finance a lash up What is the price to earnings

00:05

ratio All right You just inherited a thousand shares of

00:09

whatever dot com which trades publicly for twenty bucks a

00:12

share And you also inherited a thousand shares of pepsi

00:17

And that stock trades publicly for forty bucks a share

00:20

Your sister got the pewter bunny rabbit collection but well

00:24

you can live with that fact that you take the

00:26

thousand shares All right so what on earth do you

00:28

do now What do you do with these things Well

00:31

you have no idea Because you're an orthodontist and you

00:34

have your hands in wet mouths all day Well if

00:37

you'd inherited a truckload of floss well then we totally

00:40

know what to do with it All right Will you

00:42

check out the brokerage reports from morgan stanley on whatever

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dot com it has one hundred million dollars in revenue

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and no earnings no profits Well what Our earnings again

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Oh yeah This revenues from whatever's app sales at a

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buck Each one hundred million of them minus its cost

01:03

of goods sold Well it had to pay fifty million

01:05

bucks to apple and others to get it saps out

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There well then it had a small army of engineers

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and product people on payroll to build The app will

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subtract another thirty million box then it had rent in

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legal expenses and health care insurance and office things like

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computers and app servers All of that added up to

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be twenty million dollars and because of the accounting laws

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you have to subtract it all last year Even though

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the app it lasts a long time i had to

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take it all off the top It had a hundred

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million dollars in revenues and a hundred million dollars in

01:34

expenses and no earnings but it has fifty million shares

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outstanding which when multiplied by twenty bucks a share that's

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What the market's paying for it twenty dollars share It

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gives it a market value of a billion bucks Take

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the shares outstanding kinds of market price to get what

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the company's worth at least according to wall street buying

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and selling the shares Oh it has fifty million dollars

01:56

in cash on the books and no debt so the

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market is valuing the equity of the company at nine

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hundred fifty million dollars meaning it's valuing the earnings power

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Of the company in the future in his hands at

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nine Fifty alright so you wonder forth an honest and

02:15

would be flossed cellar that you are How khun something

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with no profits no earnings be worth a billion dollars

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Well you read through the report which notes that the

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revenues are growing really fast like one hundred percent a

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year and that the market whoever that is believes that

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the company will have two hundred million in revenues next

02:37

year and for hundred million the following year and on

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four hundred million of revenues it will have one hundred

02:43

million dollars in net earnings It'll also produce fifty million

02:48

in cash along the way so in two years it

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will have one hundred million dollars in cash on the

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books and no debt If you go back and think

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about that that you could subtract one hundred million from

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the billion and it's the nine hundred million of equity

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value back we'll get All right So you ponder that

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means that today at a billion dollars i'm paying if

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i buy it at twenty bucks a share i'm paying

03:12

nine times the earnings expected in two years Two years

03:17

From now for the equity value of this company huh

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Well is nine times earnings cheap expensive Attaway frame the

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notion Well the average snp company trades it about sixteen

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times two years out earning something like that But the

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average company is totally different from whatever dot com The

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average company is like a caterpillar Tractors or well pepsi's

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kind of average Wells fargo kind of average Well it's

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a mature company unlike whatever dot com and the people

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who write for shmoop but not mature way No Well

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caterpillar has been around for a century has a stable

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set of fires And you know what are the odds

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People still need tractors to mine food in five years

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You have pretty good odds whereas whatever dot com might

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have totally evaporated by them Yeah well what about revenue

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growth Yep Caterpillars matured gross revenues that only about eight

04:12

percent a year in a good year And it has

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a lot of capital expenses Well every decade or so

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it needs a new smelting plant to smelt engines and

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redo its manufacturing process Tio you know keep up with

04:25

the joneses or rather the blues or chains Oh and

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it pays a small dividend yeah helps well tough company

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to compare with whatever dot com but caterpillar trades at

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about sixteen times thiss years earnings and it'll grow earning

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slowly and you note that it trades at fifteen times

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and extras projected earnings and fourteen times the following year's

04:45

earnings So that's interesting caterpillar trades at a hire multiple

04:51

on two year forward earnings than whatever dot com who

04:53

does that make sense It's nowhere near ist sexy a

04:56

company but it must be the risk the market is

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discounting a lot of risk because the odds that whatever

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dot com doesn't make its four hundred million dollars in

05:07

projected app sales in two years well that's pretty good

05:11

could earn a lot less so you know you get

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it You'll keep your shares of whatever dot com if

05:16

you believe they'll really hit the one hundred million in

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earnings on four hundred million of revenues two years from

05:22

now and you'll dump the shares if you don't Well

05:25

what about pepsi Well that's company that financially sounds a

05:27

lot more like caterpillar than whatever dot com the risk

05:31

of people still drinking highly addictive caffeinated fizzy water and

05:35

salted potatoes in five years left pepsi sells a lot

05:38

of data chips Yeah really good odds Pepsi grows a

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bit faster than caterpillar it has a bit higher margins

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and it acquires competitors all the time dipping its toes

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even outside the food and snacks arena So it has

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a really big playing field that it plays on by

05:53

a lot of things and there's that global warming thing

05:56

People drink more when it's hot right So pepsi learn

05:59

about two bucks a share this year and it trades

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that twenty times earnings or forty dollars Well because pepsi

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has long term distribution contract with grocery stores and vending

06:09

machines and theme parks and other weird places it sells

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its wears well pepsi has a pretty highly predictable earning

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stream So when peopie tells the street that it'll learned

06:20

to twenty next year in two forty the following year

06:23

what likelihood Very high that it hits those numbers are

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maybe does little better because it has a history of

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under promising and over delivering and on its two bucks

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forty and earnings at forty dollars pep trades at a

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bit of a premium to the stock market overall that

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to forty and earnings on a forty dollars a share

06:39

price today means that peopie trades at sixteen point six

06:43

times two years out Earnings well the overall stock market

06:47

trades at sixteen times this year's earnings because well earnings

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are growing It trades it about fifteen times earnings two

06:53

years out Why all of these crazy comparisons That air

06:57

probably confusing you well because price to earnings ratios are

07:01

just one measure of the value of a company relative

07:05

to everything else The p e ratio is just one

07:09

metric investors used to measure the value of a company

07:13

and the basic foundation of the idea is simple If

07:16

you invest a dollar in a company today you want

07:19

to be paid back either by getting cash distributions coming

07:23

to you That overtime are much greater than that dollar

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you put in like big dividends and so on Or

07:29

you want the asset itself to simply appreciate it A

07:32

healthy fast pace about eight dollars worth of stock Well

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you want that stock to double every you know three

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four five six years something like that Alright we'll announce

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for your sister's rabbit collection Well that things should multiply

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At a good rate too unless she decides to separate 00:07:47.975 --> [endTime] them

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