2010 and 2011 revenues, gross profits, and research & development (R&D) expenses were found for 25 chemical companies from data on submitted 10Ks to the US Securities & Exchange Commission. These data was obtained because of an interest in examining the concept that a company's R&D expenses can represent how well a company’s “good” ideas (with R&D expenses reflecting such ideas) correlate with how well a company generates value. The assumption is made that if there is such a correlation, than the R&D expenses as a percentage of revenues would show a correlation with gross profit margin percentages (GPM%) for a series of chemical companies.
The following two graphs show the GPM% for 25 chemical companies plotted against the corresponding R&D expenses as a percentage of revenues for the 25 companies. These two graphs show what appears to me to be a good visual correlation between the two sets of data. That is, as R&D expenses represent a higher percentage of the revenues for a company, the GPM% goes up. Regression analysis (using Excel) was done to determine R-Square values for the two sets of data. For the 2010 data, R-Square results were 63% and for the 2011 data, 65%. Both R-Square values generally are considered to show good correlations between sets of data.
A basic finance principle is that it is primarily “ideas” (good projects) that matter in creating a company's financial value. If the assumption is that a company that puts more emphasis on R&D could be expected to generate more good ideas, then one might expect a correlation between such companies’ emphasis and the value it creates. Another assumption is that GPM% relate to values creation, with higher GPM% creating more value.
The chemical industry is a good sector to use R&D expenses as a surrogate for idea generations since, antidotally, R&D has long been recognized as critical for chemical companies in creating new products (in having good ideas). Two to five companies were selected from the US Census Bureau’s seven sub-categories (basic; plastics; agriculture; pharmaceuticals; paints; soaps; and other). (The companies identify their business sub-categories as in the 10K filings.)
The 2010 average GPM% and the percentage of R&D expenses of revenues for the 25 chemical companies are 41.7% and 5.5%, respectively. In 2011, the respective averages are 42.6% and 5.2% for the 25 companies