3.3 Methodology
3.3.1 Past Financial Performance
3.3.1.3 Correlation between patents and ROE
3.3.1.3 Correlation between patents and ROE
Figure 3-3 Correlation between patents and ROE
Reading the above correlation efficient graph about the relationship between number of patents and ROE, 17 of 106 firms show perfect or strong positive linear relationship (from 0.7 to 1.0), and 21 firms show moderate positive linear relationship (from 0.3 to 0.7), and 14 firms show weak positive linear relationship (from 0.1 to 0.3), and 7 firms indicate no linear relationship ( zero ). Meanwhile 16 firms show weak negative linear relationship (from - 0.1 to – 0.3), and 13 firms show moderate linear negative relationship (from – 0.3 to – 0.7), and 18 firms indicate perfect or strong negative linear relationship.
Checking the firms of strong positive and moderate positive correlation in details, 1 of 3 auto parts firms, 6 of 15 chemicals firms, 12 of 19 construction firms, 0 of 3 electrical firms, 2 of 6 electronic firms, 1 of 2 fertilizer firms, 6 of 16 food and beverage firms, 2 of 6 iron and
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steel firms, 1 of 6 metal firms, 6 of 24 pharmaceutical firms, 1 of 2 utility supply firms fall in the range of strong or moderate position correlation. This analysis result does not show correlation between patents and ROE
3.2.2 Comparative Financial Performance
This analysis shows the comparison of financial performance of industries, firms, largest number patents and the rest firms in the same industry if correlation exists between the number of granted patent and financial performance ratio.
3.3.2.1 Profitability
It is to measure the ability to earn income and sustain growth in both of short and long term, and provide measures of the success of the firm at generating profits, to measure the firm’s use of its assets and control of its expense to generate an acceptable rate of return.
3.3.2.1.1 Gross profit ratio
Gross profit margin reflects the efficiency, value and cost of the product. If the product is made by technological innovation, the process cost should be cheaper or the selling price should be relative higher. The product of innovative firm may have price competitiveness either by selling at higher price due to better attractiveness to customers or by making low cost with innovative production process.
(Sales-COGS) / sales
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Figure 3-4 Average number of patents per firm by industry
Analyzing the industries with the number of granted patent during the period of 2005 to 2008, the average granted patents number per year is below 10 for utility suppliers, 20 to 40 for fertilizer firms, electronics firms and construction firms, 40 to 60 for pharmaceutical firms, food and beverage firms, 60 to 90 for electrical firms and metal firms, while chemical firms and auto parts firms show around 800 granted patent. The number of granted patents of medium size electronic companies are relatively much lower than the conglomerate Samsung Electronics ( 2005: 18,000 patents, 2006 : 17,000 patents, 2007 : 12,000 and 2008 : 8,000)
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Figure 3-5 Average profit ratio per firm by industry
The firms in the industries of irons and steels, metal and electronic industries show around 10% average gross profit ratio during the period of 2005 to 2008, and 10% to 20%
gross profit ratio for utility suppliers, electrical firms, construction firms, chemical firms and auto parts firms, 20% to 30% gross profit ratio for food and beverage firms, fertilizer firms, while pharmaceutical firms shows 53% gross profit ratio. Fertilizer companies are just a few players, so they may enjoy reasonable profit. Pharmaceutical firms, food and beverage firms may keep good profit ratio from low cost of products, even with commonly believed high research and development expense. The firms with largest number of granted patent in fertilizer and chemical industries show far higher gross profit ratio, difference to be 25 % higher for fertilizer and 15% higher for chemicals, than the other firms in the same indutries, while the firms with largest number of granted patent in the other 9 industries stay close to the other firms in the same industries for gross profit
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Average profit ratio
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3.3.2.1.1.2 Comparison of firms inside the same industry
Gross profit ratio among the firms inside the same industry is compared if there is correlation with the number of granted patents. The analysis indicates that individual company in the same industry shows the positive correlation trend rather than the comparison of industry to indistry. The below is the comparison table.
Table 3-2 Comparison of profit ratio between largest number patents firm and the rest company with most number patents the rest companies
Patent number average gross profit Average No. of patents average gross profit
Utility Suppliers 6 13.6% 4 17.2% steels firms, pharmaceutical firms, food and beverage firms, fertilizer firms, eletronic firms, construction firms, chemical firms and auto part firms. While the industries that do not show positive correlation are utilitiy firms, metal firms and electrical firms. In total 8 of 11
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industries have positive correlation between the number of patent citations and gross profit ratio.
3.3.2.1.2 Return on Equity (ROE)
ROE is the bottom line measure for the shareholders, measuring the profits earned for each dollar invested in the firm’s stock. Innovative product can make higher ROE than less innovative product. ROE shows how well the company with innovative products uses investment fund to generate earnings growth. The range of 15% to 20% of ROE is desirable.
ROE is best used to compare companies in the same industry.
ROE = Net Income / Equity
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3.3.2.1.2.1 Industry comparison
Figure 3-6 Average ROE per firm by industry
The performance of ROE for the firms in 11 industries varies from negative growth to positive growth. Electronic firms have negative 32 % ROE average per year during the period of 2005 to 2008, and electrical firms show negative 24% ROE average for the same period, and metal firms do negative 2% ROE average for the same period. Auto parts firms and construction firms range their ROE average around 11% to 13%, and other industries show their ROE average less 10%. Generally speaking about ROE of all industries, the performance is under 15%, which is considered to be under desirable level of commercial entity.
In industries level, the number of granted patent does not seem to influence positively on ROE performance.
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3.3.2.1.2.2 Company comparison inside the same industry
Table 3-3 Comparison of ROE between largest number patents firm and the rest company with most number patents the rest companies
Direction of the number of granted patent is inconsistent with that of ROE performance.
Even largest number of granted patents firms in the metals, electronics, electrical industries show negative ROE growth during the period of 2005 to 2008, and the rest firms in those industries also struggle with negative ROE growth during the same period. The firms with largest number of granted patents in the auto parts, iron and steels industries enjoy around 20 % ROE growth, which is much higher than their competitors showing 4% and 9%
respectively.
3.3.2.1.3 Return on Assets
ROA is a measure how effectively the firm’s assets are being used to generate profits.
This is a useful number for comparing competing companies in the same industry.
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Technologically innovative firm do not have to invest too much in fixed assets as conventional industries. So, innovative firm may have higher ROA than the less firms.
ROA = Net income / Total Assets
3.3.2.1.3.1 Industry comparison
Figure 3-7 Average ROA per firm by industry
Electrical firms have 1% annual average ROA during the period of 2005 to 2008, while the number of granted patent is largest among the industries. Irons and steels firms, metal firms registered the patents over 70 cases with average ROA to be 3.5% and 2.1% respectively.
Pharmaceutical firms show 6% average ROA, while utility firms, food and beverage firms, construction firms reach around 4% average ROA. Electronic firms suffer from negative
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growth of average ROA during the same period.
3.3.2.1.3.2 Company comparison inside the same industry
Table 3-4 Comparison of ROA between largest number patents firm and the rest
company with most number patents the rest companies pharmaceuticals, food and beverage, constructions, auto parts keep superior characteristics to the firms with less number of patents, while largest number of granted patents in the industries of utility, metals, fertilizer, electronics, electrical and chemicals do not have correlation between the number of granted patent and average ROA .during the period of 2005 to 2008.
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3.3.2.2 Stability
This is a measure of a company’s financial leverage indicating what proportion of equity and debt that the company uses to finance its assets. A high debt to equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. The debt to equity ratio also depends on the industry in which the company operates.
3.3.2.2.1 Debt to Asset ratio
The higher the ratio, the greater risk will be associated with the firm’s operation, indicating low borrowing capacity of a firm, which in turn will lower the firm’s financial flexibility. If the ratio is less than 0.5, most of the company’s assets is financed through equity.
If the ratio is greater than 0.5, most of the company’s assets is financed through debt.
Technologically innovative company should not stay on high debt ratio in consecutive years, because the company can lower down the debt ratio after its innovative product is on the market.
Total Debt / Total Assets
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3.3.2.2.1.1 Industry comparison
Figure 3-8 Average debt ratio per firm in order from highest ratio to lowest
40 of 106 firms can be said to be through debt which means their debt to asset ratio is over 0.5 (50%), 66 firms are through equity which means their debt to asset ratio is less 0.5 (50%) as annual average during the period of 2005 to 2008. In the analysis, a few firms have a sudden increase of debt ratio in a certain year which affected bad influence to the average debt ratio to look poor. Many firms with a good number of patents also have high debt to asset ratio.
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3.3.2.2.1.2 Company comparison inside the same industry
Figure 3-9 Patent total (2005 – 2008) per company
Among 106 firms, top 20 firms have 120 to 6,000 patent citations which make the graph not to read easy, so I skipped top 20 firms to make the graph. The firms were top downed in order of the number of granted patents to see the correlation between the number of patents and debt to asset ratio during the period of 2005 to 2008.
This is to see if the firms with larger number of granted patent have less debt to asset ratio by comparing the graph trend as below. The order of the firms in the average debt ratio as below is the same order as the above of patent total.
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Figure 3-10 Average debt to asset ratio per firm in order of patents number
Average debt ratio of the firms do not show positive correlation with the number of granted patent, but top 60 firms have relatively better debt to asset ratio than the last 56 firms during the period of 2005 to 2008.
Utility supplier industry shows 50% debt to asset raito for the firm with largest number of granted patents and 53% for the rest firms. Irons and steels firms indicate 54% debt ratio for the firm with largest number of granted patents and 41% for the rest firms in the same industry. Pharmaceutical firms range 50% debt ratio for the firm with largest number of granted patents and 39% for the rest firms. Food and beverage industry, fertilizer industry, chemicals industry and electronics industry show 40% to 45% debt ratio for the firms with largest number of granted patents as well as the rest firms. Electrical firms show 103% debt ratio for the largest number of patent citations and 22% debt ratio for the rest firms, while
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Average debt ratio
Average debt ratio
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auto parts firms indicate 39% debt ratio for the firm with largest number of granted patent and 100% debt ratio for the rest firms.
3.3.2.3. Liquidity Ratio
This provides information about a firm’s ability to meet its short-term financial obligation. In general, the higher the value of the ratio, the larger the margin of safety that the company possesses to cover short-term debts. The technologically innovative company will not have high debt ratio in consecutive years, even though the debt ratio may be higher when it borrows money, but should not stay high in continuous years.
3.3.2.3.1 Current ratio
The higher the current ratio, the more capable the company is of paying its obligations.
A ratio under 1 (one) suggests that the company would be unable to pay off its obligations if they come due at that point. The current ratio can give a sense of the efficiency of a company’s operating cycle or its ability to turn its product into cash. The innovative products that technologically innovative firms produce should be easy to turn into cash with strong attractiveness to customers.
Current Ratio = Current Assets / Current Liabilitie
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Figure 3-11 Average current ratio (industry)
All of 11 industries show healthy current ratio which is above 1 (one) as annual average during the period of 2005 to 2008. Comparing the current ratio of 11 industries, Electrical firms rank highest current ratio at 3. Pharmaceutical firms and metal firms have 2.7, while fertilizer firms show 2.3 current ratio. Food and beverage firms, irons and steels firms, construction firms locate at the current ratio of 1.5 to 1.9. Utility firms, auto parts firms and chemical firms show the current ratio at 1.0 to 1.4.
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Average Current ratio (industry)
Average Current ratio (industry)
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Figure 3-12 Average current ratio per firm in order from largest number of patents to lowest
Comparing individual firms in the same industry, the firms with largest number of granted patents show higher current ratios only in three industries; utility supplier, auto parts and fertilizer during period of 2005 to 2008. Higher current ratios are shown for the rest firms which are not largest number of granted patents in the other industries. So, current ratio does not show positive correlation with the number of patent citations.
3.3.2.4 Efficiency Ratio
This ratio is used to measure the company’s use of the assets in generating sales revenue or sales income to a firm.
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3.3.2.4.1 Asset turnover ratio
The firms with low profit margin tend to have high asset turnover, while the firms with high profit margin tend to have low asset turnover, because more assets are required to generate revenue which leads to more competition and less ability to raise price. Companies in retail industry tend to have a very hihg asset turnover ratio due mainly to cutthroat and competitive price. The higher the ratio when compared to competitors or year to year trends, the more efficiently management has used the company assets to generate revenue. Less technologically innovative company may have very high asset turnover due to cutthroat and competitive pricing. The product of high asset turnover can be daily or weekly consuming, while the product of low asset turnover can be purchased once or twice per year. The technologlically innovative company will utilize its assets to generate high value and profit.
Asset turnover = Sales / Total Asset
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Figure 3-13 Average asset turnover (industry)
Each industry may request different level of capital investment to remain competitive and strengthen competitiveness, so the comparison among indusries may not give correct information in the time of industry comparison. As explained in the beginning of this thesis, all of the firms in this thesis has 500 millions US dollars as its total capital which may be a reference tool not to deviate this comparison from reasonable analysis.
Analyzing the above table, pharmaceutical industry, irons and steels industry have 0.9
which is lowest asset turnover among industries, while electronics industry, construction industry, chemicals industry and auto parts industry show their asset turnover ratio at 1.0. The rest industries have 1.2 of asset turnover ratio during the period of 2005 to 2008.
It may say that pharmaceutical, irons and steels enjoy high profit margin business, while the industries such as utility suppliers, metals, food and beverage, fertilizers and electrical
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firms are involved in price competitive market.
Figure 3-14 Average asset turnover per firm in order from largest number of patent to lowest
As for asset turnover of the firms in the same industry, asset turnover ratio is compared between the firm with largest number of granted patents and the rest firms in the same industry during the period of 2005 to 2008.
The firm with largest number of granted patents and the rest firms show their asset turnover at 0.86 and 1.63 respectively in utility supplier industry, and 0.83 asset turnover for the firm with largest number of granted patent and 0.96 for the rest firms for irons and steels industry, 0.78 asset turnover for the firm with largest number of patent citations and 0.87 for the rest firms for pharmaceuticals industry, 1.0 asset turnover for the firm with largest number of granted patents and 1.25 for the rest firms for food and beverage industry . 0.71 asset
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turnover for the firm with largest number of granted patents and 1.74 asset turnover for the rest firms for fertilizer industry. Chemicals and construction industries show similar level of asset turnover between the firm with largest number of patents and the rest firms. The rest firms shows lower asset turnover than the firms with largest number of patents in the industries of electricals, metal and auto parts.
Even though the asset turnover does not indicate considerable relationshipe with the number of granted patents, 8 of 11 industries are on the curve of positive correlation between asset turnover and patents number.
3.3.2.4.2 Degree of operating leverage
Technologically innovative firms will make the products with higher profit margin, or market controllable product with patent, which may bring higher growth in profit margin comparing that of growth in sales revenue.
Degree of operating leverage =
Percent change in gross profit / percent change in sales
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Figure 3-15 Change of gross profit and change of sales (2005 to 2008)
Analyzing the trend of growth between sales and gross profit during the period of 2005 to 2008, it is hard to find positive correlation between the number of granted patents and the growth trend of net income as well as sales growth.
The firm with largest number of patents in utility supplier industry show incremental change of sales from 2005 to 2008, while the gross profit fluctuates year by year during the
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change of sales growth and gross profit. The sales of the firm with largest number of patents in pharmaceutical industry shows increase year by year, while the gross profit trend of growth fluctuates year by year during the period of 2005 to 2008. The sales change of 15 of the other 23 firms in pharmaceutical industry moves to same direction with the change of gross profit, while 8 of 23 pharmaceutical firms do not. Change of sales growth is positive year by year for the firm with largest number of patents in metal industry as the gross profit increases during 2005 to 2008. 3 of the other 5 firms in metal industry indicate same trend between change of sales growth and gross profit during 2005 to 2008, while 2 of the other 5 firms move differently. The firm with largest number of patents in irons and steels industry has positive correlation between patent numbers and change of sales growth, change of gross profit growth.
6 of the other 9 firms in irons and steels industry move on same direction, while the other 3
6 of the other 9 firms in irons and steels industry move on same direction, while the other 3