Trending
Written by: Shiv Patel | Advisor Asset Management
Growth investors are continuously looking to identify the next transformative company that can alter the course of traditional industries. And while there are many measures investors utilize in their search, we believe one stands above the rest: Persistent spending on research and development (R&D). However, it is important to recognize that investing in companies with high R&D spending isn’t just about short-term gains, it's about recognizing the potential for long-term value creation. Historically, companies that consistently reinvest in R&D often do not experience robust sales growth until down the road, but ultimately are enabled to maintain their competitive positions as well as potentially expand their market presence. This can lead to compounding returns for those investors who are patient enough to stay the course.
Innovation as a Catalyst
R&D spenders demonstrate a commitment to innovation, constantly seeking new products, technologies, or services to maintain their competitive edge. This commitment often translates into a pipeline of groundbreaking offerings that can transform industries and capture additional market share. As these innovations materialize into tangible products or services, they can drive substantial revenue growth, which stands as a vital indicator of a company's strength and market demand for its offerings.
Three years ago, the average company in the S&P 500 Growth Index spent $1.92 billion in R&D expenses, 21% higher than the average company in the S&P 500 Index. Three years later, S&P 500 Growth companies currently have an average of 19.33% growth in sales compared to 15.47% for the S&P 500. This highlights how growth-oriented companies who chose to spend more on R&D are now seeing their investments materialize into elevated sales growth. Furthermore, on a 1-year basis, that sales growth was 18.93% for the S&P 500 Growth Index compared to 13.40% for the S&P 500 Index.
Source: FactSet, as of 4/30/2024 | Past performance is not indicative of future results.
When strong sales are coupled with continued R&D spending, the company signifies that it is not only able to attract new customers but also retain them through continuous innovation. Such companies are often at the forefront of market trends, adapting swiftly to changing consumer preferences and technological advancements.
Innovation for Risk Mitigation
While investing in growth companies inherently carries some level of risk, focusing on companies with substantial R&D spending can mitigate certain risks. These companies often have diversified revenue streams stemming from a range of innovative products or services. Additionally, their commitment to innovation can act as a barrier to entry for competitors, reducing the threat of disruption.
Several companies have exemplified how following the R&D spending trail translated to great competitive advantages. Many of the well-established tech giants have consistently allocated significant resources to R&D and establishing their market dominance. Similarly, many biotechnology companies poured themselves into R&D initiatives during the onset of the COVID-19 pandemic in effort to be the leading, transformative force within the industry. As a result, the companies with the most innovative solutions became the new market leaders, and investors that identified their potential early reaped the significant rewards.
Due Diligence of Innovations is Key
While the potential rewards of investing in transformative technologies is enticing, it's essential for investors to conduct thorough due diligence. Not all disruptors will succeed, and the landscape is littered with examples of promising ventures that ultimately faltered. Understanding the technology, the market dynamics, and the company's competitive positioning is crucial to get in on the ground floor of transformative developments. By identifying companies with a track record of innovation and a commitment to long-term value creation, investors can position themselves for potentially lucrative returns over time while mitigating certain risks that come along with it.
Related: Future-Proof Your Practice by Reaching Generation Z