Cutback in R&D spending raises red flag By Matt Krantz, USA TODAY Posted 10/12/2005 10:34 PM
Are companies squandering the future keeping their shareholders happy?
While third-quarter corporate profits, being reported now, are expected to soar an additional 15% compared with the year-ago quarter, companies are shoveling much of their fat cash flows back to investors through dividends and share buybacks. In the process, research and development, better known as R&D, is being ignored.
Companies spent slightly less on R&D as a percentage of revenue in the second quarter than they did a year ago, according to a USA TODAY analysis of Capital IQ data, looking at members of the Standard & Poor's 1500 index. Spending on R&D by companies in the benchmark S&P 500 index has grown 3.3% over the past four quarters, well below the 11.6% growth in revenue during the same period, S&P says.
Meanwhile, the dollar value of stock buybacks and dividends, two ways to return cash to shareholders, jumped 92% and 13%, respectively, in the second quarter, says Howard Silverblatt, market analyst at S&P.
The lackluster R&D spending concerns some. Companies "are going to have to increase sales, and to increase sales, they are going to have to increase other things like R&D," Silverblatt says.
One reason companies are R&D averse: They fear investor retribution. In a reversal from the late 1990s, when dividends were dissed and companies couldn't spend enough on R&D, investors now want executives to return cash to them, says Jim Paulsen, strategist at Wells Capital Management. Investors and executives fear R&D spending is "being thrown down a rat hole," Paulsen says.
A new study by consultant Booz Allen Hamilton encapsulates these fears. It found that big R&D spenders don't get returns on their outsized investments and that R&D spending has no effect on growth, profitability or shareholder return. R&D is "a roll of the dice of what you will get back," says Barry Jaruzelski, vice president of Booz Allen and co-author of the study that looked at 1,000 companies going back six years.
But Paulsen says the study's methodology is flawed because it began measuring the effectiveness of R&D spending right when it was peaking and the economy tanked. Tracking the yield of R&D spending back 30 or 40 years would likely have contrary results, he says.
But while R&D spending has been soft, it's probably not as weak as it appears, says Ron Freedman, CEO of R&D tracker Research Infosource. He says many companies are adding R&D units overseas, so they're getting more research capacity for less money.
Paulsen thinks companies will resume R&D spending. "Unless (the economic) recovery dies on its own," Paulsen says, "at some point, companies will say maybe this is OK" to spend on R&D.
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