Using Adjusted PEmR to Value Tech Companies Investing Heavily in R&D

Tech companies are different. Unlike traditional businesses where profits come mainly from current operations, the profitability of many technology firms is deeply tied to year-on-year investments in innovation—primarily through Research and Development (R&D). This unique characteristic means traditional valuation metrics like the classic Price-to-Earnings (P/E) ratio can be misleading and often penalize companies that aggressively invest in their futures.

Why Conventional P/E Ratios Fall Short for Tech Companies

Traditional P/E ratios are calculated using net income (earnings) reported on the income statement, where all R&D expenses are fully deducted in the year incurred. For companies with substantial R&D spending—which is common in technology sectors—this accounting treatment can dramatically reduce reported profits, resulting in inflated P/E ratios.

This creates a paradox: companies investing the most in future growth and innovation appear less profitable today and thus “overvalued” by traditional P/E standards, even though their investments may generate substantial earnings years down the line.

What is the Adjusted PEmR Model?

The Adjusted Price-to-Earnings plus R&D (Adjusted PEmR) model modifies the classic P/E ratio to better reflect the economic reality of innovation investments. Instead of treating R&D as a pure immediate expense, the model treats most of it as a capital investment—similar to how companies depreciate equipment over time.

What we are doing is removing 75% of the R&D spend and adding that to profitability.

We are also then using last year growth models and extending them +1 nd +2 years to take into account the ‘growth’ nature of these enterprises

Here, 75% of R&D expense is added back to net income, implying that this portion of R&D should be considered as an asset generating future earnings rather than costing profit today.

Why 75% and Not 100%?

The choice of 75% is a practical estimate to balance the view that:

• Most R&D drives long-term value creation and should be capitalized,
• But a portion of it (25%) may still relate to current operations and risks that justify treating part as expense.

This assumption can be calibrated, but 75% has been found useful for valuing many tech firms.

Benefits of Using Adjusted PEmR for Tech Valuation

• Fairer valuation: Companies that invest heavily in technology and innovation appear less penalized, reflecting the true economic value of their investments.
• Better comparability: Firms at different stages and with different R&D intensities can be compared more equitably.
• Growth sensitivity: When combined with year-over-year earnings growth projections, the model can produce forward-looking valuation multiples (like PEmR+1, PEmR+2), giving investors insight on how innovation investments impact profitability over time.
• Reflecting capitalized innovation: By treating most R&D as capital investment, the model aligns more closely with how assets contribute to value in the long term.

When to Use Adjusted PEmR

• For technology, biotech, and software companies, where R&D spending is a core driver of competitive advantage.
• When comparing companies with varying R&D intensities to avoid over-penalizing innovation leaders.
• For investors focused on long-term growth potential rather than just current accounting profitability.
• When you want a valuation framework that integrates investment (capex) mindset into earnings rather than pure expense recognition.

Example: Why It Matters

Companies like Nvidia, Meta, and Tesla spend tens of billions annually on R&D. Without adjustment, their earnings look low, and their P/E ratios skyrocket, which can deter value-focused investors. Using Adjusted PEmR, their earnings “normalize” by capitalizing most R&D, yielding valuation multiples more consistent with their real economic strength and growth outlook.

By adopting the Adjusted PEmR approach, analysts and investors can better understand the value of innovation-driven growth in tech companies. It moves beyond accounting quirks and aligns valuation with how R&D investments actually drive future profits rather than penalizing firms for spending on their own potential.

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