Big Ideas, Big Spending, Big Payoff
Wouldn't it be nice to know that capitalism rewards the patient pursuit of great ideas? That business is better when it funds the imagination and realization of things beyond our reach?
Here's the good news: Among large companies that spend money on research and development, bigger investments pay off. Shareholders, for the most part, get the biggest returns from the allocation of the largest percentage of corporate sales to R&D.
The link between innovation and R&D spending is complicated and contested. The skeptical view is represented by a 2011 Booz & Co. report arguing that highly innovative companies don't necessarily invest much in research. Many successful companies don't report any R&D expenditure at all.
Among the companies that do, there's a link between R&D spending and shareholder value.
Start with the Global 500, the world's biggest 500 companies by market capitalization. Almost half of them, 239, reported spending at least something on R&D in the last three years.
These were mainly technology giants like Yahoo! Inc. and Adobe Systems Inc., science pacesetters like Vertex Pharmaceuticals Inc. and Gilead Sciences Inc., and makers of engineered products like cars, airplanes and electronics gear. Financial companies and sellers of consumer goods were least likely to report R&D expenditures.
Among the companies reporting R&D spending, the ones that grew the most during the past year and over the last three years tended to lead the way in R&D investment, according to data compiled by Bloomberg.
Look first at the fastest-growing quarter of the R&D spenders, the companies whose market capitalization expanded the most since 2012. They increased in value by an average of 251 percent while spending an average 10.25 percent of net sales on R&D.
The next quarter appreciated an average of 69 percent. They invested less: 7.91 percent of revenue went to R&D. The third quarter's growth averaged 36 percent, with 6.4 percent of net sales invested in R&D.
The slowest-growing quarter of the Global 500 companies that invested something in R&D lost an average of 8 percent of their market cap, having put an average of 3.24 percent into research and development, according to Bloomberg data.
Part of this story sounds familiar. We expect younger companies like Google Inc. to rely on R&D for growth. Here's what's surprising: The data show older companies performing better over the long term in the stock market when they are committed to investing in innovation.
Take Regeneron Pharmaceuticals Inc., the Tarrytown, New York, maker of products to treat cancer. Founded in 1988, 10 years before Google, its market cap soared 716 percent over the past three years while investing 63 percent of its net sales of $3 billion in R&D. At the other end of the scale, Amgen Inc., a biotech company based in Thousand Oaks, California, invested about half as much in R&D -- 20.8 percent of its net sales -- and saw its shares climb 137 percent during the same period, about a fifth of Regeneron's growth.
Low R&D spending also appeared to depress the performance of CSL Ltd., the Australia-based maker of pediatric and adult vaccines. Its shares climbed a comparatively unimpressive 60.24 percent in three years while investing 8.3 percent of its net sales in R&D. In contrast, Vertex, a Massachusetts company that develops treatments for cystic fibrosis, allocated 81 percent of its net sales to R&D and its market cap increased 313 percent during the same period.
Even where the commitment to R&D is lowest among the companies that commit to it at all, there is a difference. AT&T Inc., based in Dallas, invested just 1.13 percent of its net sales in R&D the past three years and its market cap rose a paltry 3.23 percent. BT Group Plc, its London-based telecommunications services counterpart, invested 4 percent of its sales in R&D and saw its shares appreciate 108 percent.
To be sure, not all companies that invest substantially in research and development see a corresponding benefit to shareholders. Pfizer Inc., the pharmaceutical giant, spent 14.36 percent of its net sales on R&D the past three years, and its market cap climbed only 22.72 percent in the period.
That's an exception. Most of the big companies that invest consistently in R&D wind up benefiting their shareholders.
Few companies illustrate this pattern more emphatically than Tesla Motors Inc., the California-based maker of high performance electric vehicles. It isn't profitable, yet performs like a thoroughbred when it comes to shareholder value. At No. 408 in the Global 500 with a market cap of $31 billion, it's worth more than 50 percent of the value of General Motors Co. Tesla's R&D investment of 48.67 percent of its net sales helped deliver one-year and three-year returns of 133 percent and 836 percent -- impressive evidence there's a big payoff when business invests in the biggest ideas.
(With assistance from Shin Pei)
(Corrects description of Vertex Pharmaceuticals' products in 13th paragraph.)
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