In the current economic environment, public capital markets have become increasingly demanding when it comes to explanations of significant R&D expenditures aimed at higher-risk, longer-term payoffs.
Compared to just two years ago –– when moonshot investments like the metaverse were welcomed by the capital markets –– that appetite for risk has changed. The heightened scrutiny among today’s investors can be attributed to several factors: general sentiment about the state of the economy; compression of time horizons; leeriness around a public “techlash”; and the impact of rising Treasury (risk-free) rates on discount rates, to name a few.
Amid these adverse and unpredictable conditions, today’s business leaders need to publicly showcase the long-term growth potential of their strategic R&D expenditures in clear-cut terms. Rather than viewing these expenses as undisciplined or unnecessary, investors need to see them as potentially transformative –– thereby elevating the company’s long-term value.
With effective communications strategies, major R&D investments can still be perceived positively by investors, rather than dragging down their stock price. Getting there requires understanding how company valuations are determined in the capital markets.
A company’s valuation model typically takes the following factors into account:
- Current performance analyses delve deep into the company’s financial statements, including income statements, balance sheets, and cash flow statements. The goal is to evaluate historical financial performance and identify trends that may impact future financial health.
- Growth evaluations focus on a company’s ability to generate future revenue growth, considering factors such as market size, competitive position, and innovation capabilities.
- Industry analyses examine the company’s position within its industry, accounting for aspects like industry trends, competitive dynamics, and the regulatory environment.
- Competitive analyses explore the company’s competitive landscape, including competitors, suppliers, and customers. This involves assessing market share, pricing power, and customer loyalty.
Combined, these factors determine a company’s intrinsic value. In most cases, investors use what’s called a discounted cash flow (DCF, or discount rate) analysis to estimate the present value of future cash flows, taking into account a company’s management, growth potential, financial performance, and risk profile. DCF analyses are used as a companion to other valuation metrics like price-to-earnings, price-to-book, and price-to-sales, which are used by investors to compare and contrast the company’s current financial performance to that of its peer set. Meanwhile, the DCF is where R&D investments are most likely to be factored in by investors.
A company’s DCF rate is not some static number defined solely by objective measures; it’s a calculus that’s based on different inputs that are subject to the influence of effective communications strategies. In today’s markets, one tool that can be used to influence that calculus is foresight –– specifically, scenario planning.
For decades, scenario planning has been used by foresight-minded leaders to inform internal decision-making and operations. But because of the complications around publicly communicating these R&D-focused scenarios (both from a communications and competitive standpoint), in previous earnings cycles, they may not have been a common focus of investor relations.
Today, publicly sharing insights from a company’s scenario planning work can be a prudent way for leaders to not only justify their R&D spending among investors, but cultivate confidence in the future. In short: By providing investors with a clearer view of scenario work, leaders can positively influence their company’s discount rate (and as a result, its public valuation).
- Share insights into intersecting uncertainties: Help investors grasp the organized complexity of the decision-making process by discussing multiple uncertainties that your company has considered, such as market trends, technological developments, and regulatory changes.
- Be transparent about the R&D decision-making process: In the face of these uncertainties, clearly explain the scenario planning and foresight methodologies used to inform your R&D investment. Explain the factors that were considered and the rationale behind the chosen strategy.
- Showcase rigorous management processes: Share how your company manages risk and execution while maintaining alignment between the board, C-suite, and R&D teams. This highlights your commitment to effectively executing the chosen strategy.
- Offer visibility into alternative strategies: The paths you decided not to pursue are often just as enlightening as the paths you did. Share alternatives that were considered but ultimately didn’t fit as part of your strategic vision, along with the reasons for their exclusion. This demonstrates the thoroughness of your analysis and decision-making process.
- Map out how and when your R&D investment will pay off: Help investors understand the potential long-term value created by significant R&D expenditures. Detail the expected outcomes and timelines to get there, and how the investment aligns with the company’s larger strategic vision.
There’s no one-size-fits all solution to communicating the value of R&D investments. While these themes may resonate widely, investors are a highly perceptive bunch; they’ll expect bespoke answers to their questions about the direction of the company. Foresight can’t be faked or scripted.
Increasingly, clarity in risk-taking is not only welcomed by investors –– it’s demanded. By offering a clearer view into the once-unseen scenarios behind their R&D decisions, business leaders help investors better understand (and reward) strategic investments –– regardless of macroeconomic pressures.