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Ken Fisher and the Price to Research Ratio

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David Chulak
Jan 31, 2012
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Any investor that has followed the techniques of Kenneth Fisher, writer at Forbes magazine for over 25 years and investing guru, has discovered that Fisher’s methodology is ever being refined. Aside from his P/S ratio introduced in his book, “Super Stocks,” Fisher also introduced investors to a "price to research ratio." You will still discover Fisher occasionally talking about the P/S ratio, but the price to research ratio appears to have disappeared from the radar screen.


It is this ratio that I would like to revisit.


One finds his book “Super Stocks” still rewarding because Fisher lays out an investing methodology that still leads to satisfactory returns, even if he has personally strayed away and/or altered it to suit himself. In one of his latest books, “The Only Three Questions That Count,” Fisher introduces investors to a little statistical lesson on casual correlations and the correlation coefficient. While the concepts sound complicated, they are actually easy and he teaches investors how to “credibly” disprove that any two events are related to one another. This lesson alone makes the book worthwhile once you grasp the concept. Perhaps it was the use of this concept that silenced Fisher on the price to research ratio. Whatever the case, it does not appear to raise its head again in his writings.


Fisher’s Price to Research Ratio was simply calculated by dividing the company’s market capitalization by the amount of research and development shown on the income statement over the last full 12 months. He determined that if the:


Price to Research Ratio:


>15 = Fail


>10 or ≤ 15 = Pass (barely)


≥5 or ≤10 = Pass




Recently, Merck (MRK, Financial) came under fire in some media reports for the amount it spent on R&D, some complaining that it was too high. Let’s take a look at Merck:


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Obviously, 2010 stands out, as does the number for the last 12 months at $10,565. The jump was enormous. CEO Kenneth Frazier found himself justifying the large number to investors that criticized the high R&D expenditures. So how does Merck compare on R&D spending to its competitors?


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Merck has the best score behind LLY. In fact, of these nine companies, only three have a passing score. So what does this mean or what does it tell us?


It’s an interesting comparison and should be cautiously used to identify companies prepared to invest heavily for the future; however, it should always be remembered that no amount of money guarantees success in the medicine pipeline. Ultimately, you discover those that are committed to spending vast amounts to create new profitable products, but the number does not guarantee that the result will be a beneficial one. The question one must ask themselves is whether the number changes anything as your are researching a stock amongst its competitors. Beckton Dickinson (BDX, Financial) and Johnson & Johnson (JNJ, Financial) have high numbers that fail. Should this discourage an investor? I find it rather subjective and the result may depend on factors we are not seeing. In due course, we are left to decide for ourselves the benefit of the ratio — if any.


Last December, CEO Kenneth Frazier’s response in his defense of the high R&D budget stated, “…I think it’s important to keep in mind that you’re not necessarily running the company for the immediate reaction of the stock market. What we’re really trying to do is run the company to create sustainable long-term value for our shareholders.”


That response makes it sound as if the criticism was coming from short-term investors that only cared about a quick earnings jump and not concerned for long-term value. Frazier went on to acknowledge the difficulty in developing new products but stood fast in the belief that long-term value would be created. Good job Mr. Frazier and well said.


Robert Hagstrom’s “The Essential Buffett” identifies tenets of management that Warren Buffett looks for. Some of the tenets are:


· Managers that behave like owners and do not lose sight of the company’s prime objective of increasing shareholder value.


· Rational decisions by management that report fully and genuinely to the shareholders.


· Managers that have the courage to resist the institutional imperative of following their peers.


What perhaps strikes me more than anything, was the new-found liking I discovered for the Merck CEO and the Buffett tenets seemed a good fit for Mr. Frazier.


I can only conclude that Merck is set on the future and in this difficult economy is preparing for the pipeline down the road when things improve. I’m not long on Merck…. but I’m much closer.
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