Price-Growth Flow

What Is Price-Growth Flow?

Price-growth flow is a financial ratio that identifies companies that are producing solid earnings while making hefty investments in research and development (R&D). A high price-growth flow measure indicates that a company is likely able to profit off of innovation and invention.

The Formula for Price-Growth Flow

It is measured using the following formula: 

Price-Growth Flow = EPS + R & D Per Share Price Per Share where: EPS = earnings per share \begin{aligned} &\text{Price-Growth Flow} = \frac{ \text{EPS} + \text{R \& D Per Share} }{ \text{Price Per Share} } \\ &\textbf{where:} \\ &\text{EPS} = \text{earnings per share} \\ \end{aligned} Price-Growth Flow=Price Per ShareEPS+R & D Per Sharewhere:EPS=earnings per share

Understanding Price-Growth Flow

Price-growth flow is an expression of earnings power and potential growth relative to the current price per share. As the formula above shows, the ratio divides earnings per share (EPS) plus R&D expenditure per share by the share price.

Analysts look at the metric for a window into a company's capital allocation structure. For example, management may spend more on developing new products and services than on current profit centers. The thought is that low earnings can be compensated with greater R&D spending and vice versa. If a company decides to spend on today and neglect the future, current earnings per share may exceed R&D spending. Both cases result in a high reading of the ratio, meaning solid earnings per share or R&D spending. That way, investors can evaluate potential earnings growth now and in the future.

Price-Growth and R&D Capabilities

But price-growth flow isn't telling of how effectively management allocates capital. A large R&D bill, for instance, does not guarantee that new product launches or market implementations will generate profits in future quarters. Meanwhile, robust earnings growth fails to give investors insight into future prospects or growth opportunities. An optimal ratio is one that strikes a balance between earnings and research & development without tilting entirely to one metric.

In the case that price-growth flow records a low reading, it tells investors that the share price has deviated well beyond fundamentals. In short, market activity is being driven by something other than current earnings growth or from potential innovation. It could be political, economic or something completely unrelated driving day to day movement. In that case, investors would be wise to monitor the news cycle, economic data, or other financial metrics like price-to-sales and price-to-book.