Spending on big ideas brings a big pay-off RESEARCH & DEVELOPMENT

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 realisation 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 research and development (R&D).

The link between innovation and R&D spending is complicated and contested. The sceptical view is represented by a 2011 Booz & Company 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 capitalisation (cap). 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! and Adobe Systems, science pacesetters like Vertex Pharmaceuticals and Gilead Sciences, 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.

Look first at the fastest-growing quarter of the R&D spenders, the companies whose market cap 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.

Innovation

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 R&D, according to data.

Part of this story sounds familiar. We expect younger companies like Google to rely on R&D for growth. Here is what is 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, the 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 $3 billion (R35bn) net sales in R&D. At the other end, Amgen, a biotech company based in California, invested about half as much in R&D – 20.8 percent of its net sales – and saw its shares climb by 137 percent during the same period.

Low R&D spending also appeared to depress the performance of CSL, 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 Pharmaceuticals, a Massachusetts company that develops drugs for treating viral diseases, 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, based in Dallas, invested just 1.13 percent of its net sales in R&D over the past three years and its market cap rose a paltry 3.23 percent. BT Group, its London-based telecoms 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 R&D see a corresponding benefit to shareholders. Pfizer, the pharmaceutical giant, spent 14.36 percent of its net sales on R&D over the past three years, and its market cap climbed only 22.72 percent in the period.

That is an exception. Most of the big companies that invest consistently in R&D wind up benefiting their shareholders.