Research On The Rise

5/16/2011


As companies gain confidence in the recovery and deploy cash stockpiled during the recession, spending on research and development has picked up. 

For the 204 companies in the S&P 500 Index that have reported R&D spending in each of the past five years, such spending rose 9% to $177.4 billion in their last fiscal year, bouncing back from a 6% decline a year earlier. Growth was broad-based, with all sectors except industrials reporting increases. However, health-care and technology companies combine to account for about 70% of reported R&D spending, and they dominate the list of heavy spenders listed below.

R&D Spending for S&P 500 companies
R&D Spending
Sector (No. of Companies)
Total
($Billion)
% of
Total
Index
1-Year
Change
(%)
% of
Sales
Consumer Discretionary (17)
9.9
5.5
10.6
3.3
Consumer Staples (25)
5.4
3.0
4.1
1.1
Energy (9)
3.5
1.9
3.9
0.4
Health Care (36)
57.8
32.3
19.0
13.8
Industrials (35)
23.9
13.3
(1.7)
3.2
Technology (64)
71.0
39.7
5.0
8.5
Materials (23)
6.2
3.5
7.9
2.5
Telecom Services (1)
1.3
0.8
36.4
1.1
Titans of R&D — the 10 largest spenders
R&D Spending Last Year
Company (Price; Ticker)
Billions
($)
% of
Sales
1-Year
Change
(%)
% of
S&P 500
Merck ($37; MRK)
10.99
24
88
6
Pfizer ($21; PFE)
9.54
14
21
5
Microsoft ($26; MSFT)
8.71
14
(3)
5
Johnson & Johnson ($66; JNJ)
6.84
11
(2)
4
Intel ($23; INTC)
6.58
15
16
4
IBM ($170 IBM)
5.72
6
4
3
Cisco Systems ($18; CSCO)
5.27
13
0
3
Ford Motor ($15; F)
5.00
4
2
3
Eli Lilly ($39; LLY)
4.93
21
12
3
Boeing ($80; BA)
4.12
6
(37)
2

Different approaches

Not every company looks at R&D the same way. Consider IBM ($170; IBM) and rival Hewlett-Packard ($42; HPQ). IBM has spent more than $5 billion on R&D in each of the past eight years — a steady 5% to 6% of sales — gradually building up its analytics and data-storage businesses. That spending allowed IBM to expand via home-grown products, augmented by small, niche acquisitions.

H-P took a different tack, slashing annual R&D investment 28% to $2.96 billion over the past eight years. R&D accounted for just 2.3% of Hewlett-Packard's sales in fiscal 2010 ended October, less than one-third the rate in fiscal 2002.

Last summer, IBM sat comfortably on the sidelines as H-P and Dell ($16; DELL) — whose own R&D spending equaled just 1.1% of sales in fiscal 2011 ended January — bid up the price of data-storage company 3PAR to $33 per share, up from less than $10 before the takeover news. H-P's new CEO, Leo Apotheker, has pledged to increase R&D spending.

Of course, the simple spending of research dollars does not guarantee the innovation needed to establish a market-leading position. Consider that Microsoft ($26; MSFT) has plowed 14% to 15% of its sales into R&D over the past five years. In terms of new products, Microsoft has little to show for that $39.59 billion. True, its Xbox video-game system is a hit. But forays into smartphones, digital-music players, and computer tablets have all flopped. Apple ($349; AAPL), by comparison, has shown more prudence with its purse strings. During that same five-year period, Apple spent $5.72 billion on R&D — about 3% of sales — while creating its wildly popular iPhone and iPad tablet computer.

Below, we profile three companies that have invested their research dollars effectively.

Abbott Laboratories ($53; ABT) plans to spend about 10% of sales on R&D in 2011, in line with its average over the last four years. That spending has built a pipeline rich with potential drugs for cancer, multiple sclerosis, and hepatitis C. Abbott also plans to introduce about 20 new medical devices and technology advancements in the next five years, including new stents and laser equipment to treat cataracts.

A pair of acquisitions completed last year helped boost Abbott's presence in emerging markets. More than $8 billion, or 23%, of Abbott's 2010 sales came from emerging markets. Management forecasts revenue from emerging markets to exceed $14 billion in 2014 and account for more than 30% of total sales.

The 2011 consensus profit estimate calls for $4.60 per share, implying 10% growth. Shares trade at less than 11 times that estimate, a 14% discount to the average pharmaceutical stock in the S&P 1500 Index. Abbott, yielding 3.6%, is a Long-Term Buy


Oracle ($36; ORCL) has spent tens of billions of dollars on acquisitions in the past six years. But Oracle helped seal its latest high-profile deal, the $7.5 billion acquisition of Sun Microsystems, with European regulators through a pledge to invest in the development of the open-source MySQL software program. That demand actually played to one of Oracle's strengths. The technology giant complements its aggressive acquisition strategy by pouring billions more into its research-and-development program every year.

Oracle tends to plow 12% to 13% of sales into research. In fiscal 2011 ending May, Oracle sees R&D spending ramping more than 20% to exceed $4 billion, which would mark the 10th increase in the last 11 years. Oracle funds these investments out of its own prodigious cash flow. Cash provided by operations has risen in each of the last seven years and surged 49% to $3.62 billion in the first half of fiscal 2011. Oracle is a Focus List Buy and a Long-Term Buy.


Varian Medical Systems' ($71; VAR) active R&D program concentrates on X-ray imaging for both the medical and industrial markets. Varian's research efforts were rewarded when its proton-therapy system — radiotherapy for lesions and tumors — gained U.S. approval in January. In early May, Varian said it was close to booking its first U.S. order for this new product, a deal valued at roughly $88 million.

R&D has generally accounted for 6% to 7% of sales over the past decade. During that period, sales rose at an annualized rate of 13%, while R&D spending grew at a 14% clip.

The company sees revenue exceeding $4 billion by fiscal 2015, versus $2.36 billion last year, implying annualized growth of 11%. Management targets long-term growth in earnings per share of 10% to 15%. Varian Medical is a Long-Term Buy

R&D LEADERS
Below are 12 companies with impressive research-and-development spending. All of the stocks earn A (above average) ratings on our Monitored List, and companies recommended for purchase are presented in bold.
R&D Spending Last Year
No. of R&D
Increases
Annualized R&D
Growth
Quadrix Scores
Company (Price; Ticker)
Millions
($)
% of
Sales
Change
(%)
5 Yrs.
10 Yrs.
5 Yrs.
(%)
10 Yrs.
(%)
Quality
Overall
Sector
10 years of higher spending
Apple ($349; AAPL)
1,782
3
34
5
10
27
17
100
99
Technology
L-3 Communications ($84; LLL)
412
3
9
5
10
10
15
75
92
Industrials
Qualcomm ($57; QCOM)
2,549
23
4
5
10
20
20
87
88
Technology
Varian Medical ($71; VAR)
157
7
6
5
10
14
14
94
61
Health Care
Big spenders (as a percent of sales)
Biogen Idec ($97; BIIB)
1,494
32
16
4
8
15
36
94
88
Health Care
Bristol-Myers ($29; BMY)
3,556
18
(2)
4
7
5
6
72
86
Health Care
Intel ($23; INTC)
6,576
15
16
2
6
5
5
90
100
Technology
Qualcomm ($57; QCOM)
2,549
23
4
5
10
20
20
87
88
Technology
5-year growth standouts (where R&D is at least 5% of sales)
Abbott Labs ($53; ABT)
4,038
11
39
4
7
17
12
74
92
Health Care
Gilead Sciences ($41; GILD)
1,073
13
14
4
7
31
23
97
83
Health Care
Oracle ($36; ORCL)
3,254
12
17
5
9
16
12
96
88
Technology
Qualcomm ($57; QCOM)
2,549
23
4
5
10
20
20
87
88
Technology
Note: Quadrix scores are percentile ranks, with 100 the best.

 


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