Sector Views

Research & Development Benchmarking – proceed with caution

This article is the second in our series covering the inconsistency of EBITDA measures reported in accounts on adoption of IFRS 16 and what it means for investors.

To recap, investors must exercise caution when extracting EBITDA measures for calculating EV / EBITDA multiples because on adoption of IFRS16, EBITDA is inconsistent with prior reporting and may have been inflated.

Another commonly referenced measure extracted from accounts is the R&D to Revenue percentage, which investors and Boards use to make and monitor strategic investment decisions in new product.

A company spending 5% of revenue on R&D is perceived as possessing lower growth potential, and value, than one spending 25%.  A Board may increase or decrease their R&D to revenue spend to align with peer groups and market norms. For tech companies, there is a widely-held view that to be considered innovative, ahead of the competition, and of value, a company should be allocating up to 20% of revenue to R&D spending, and up to 50% when expanding product sets.

We recently collated R&D spend data from Annual Reports to compare against published benchmark sector R&D data.  Extracting a consistent and accurate R&D figure proved difficult, which could have significant consequences for Boards and investors.

There is significant variation in the completeness, clarity, style and form of company R&D spend disclosures. Our research showed an inconsistent location for the disclosure of R&D spend, with variable quality of the disclosure itself ranging from disclosure of:

  1. The R&D cost passing through the P&L;
  2. (1) above plus amortization of capitalized R&D;
  3. (1) and (2) above plus capitalized R&D;
  4. Various combinations of the above; and
  5. No disclosure

In most cases we could determine the R&D cost passing through the P&L; adding this to the capitalized R&D to arrive at total R&D spend (i.e. cash spend).

At extremes, it was easy to inadvertently extract the wrong R&D data.  Small mistakes extracting the data could lead to a range of ratio outcomes between 10% and 30% depending on the figures extracted – one example showed the ratio was 12% but without care investors could easily arrive at 24%.

Reporting of R&D data is lightly regulated by accounting standards, relying mostly on the Companies Act for UK companies.  As a result, arriving at the R&D spend figure can be a fair amount of work and it seems likely that sector benchmarks are being given without significant rigor.  Investors and Boards need to take care when calculating and using the resulting R&D spend benchmark data when making investment decisions.

In our next article, we consider whether R&D spend ratios are a useful tool for investors and boards, and consider alternative approaches.


Kestrel’s Sector Views should neither be construed as investment research, nor the provision of investment advice, nor a recommendation. This article should be viewed as short term commentary only based on the latest economic statistics, company results or information on upcoming releases or events. It is only a brief unsubstantiated summary of Kestrel’s opinion on such information as at the date of publication and no reliance may be placed upon any contents of this article by the recipient.

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