March 1, 2011

The direct impact of R&D expenditures on market capitalization: an analysis of large cap companies – Google, Apple, Microsoft, HP, IBM, 3M, Intel, Xerox, Oracle, Cisco, Caterpillar, GE, Johnson & Johnson, Dell

As many of my readers know, I’m a big proponent of R&D expenditures for companies developing products, services, and intellectual properties. And for some time, I’ve been thinking about analyzing the effect of R&D expenditures on two metrics: market capitalization and revenues. Today I’m looking at the impact of R&D on market cap. As important as revenues are, the CEOs of most public companies are forced into keeping market cap (effectively their stock price) front and center in their priority list. I’ll perform similar analysis on the effect of R&D on revenues in the near future.

The analysis is quite simplistic. I plotted the R&D expenditures per number of employees, against the market cap per number of employees. Given that it typically takes 2-3 years for R&D expenditures to pay off, the R&D numbers are taken from FY08 annual reports of these companies, and the market cap numbers are taken from February 28, 2011. The number of employees corresponds with the timing of the metrics so that it evens out any acquisitions or layoffs the companies may have gone through. Clearly, many other variables should be considered in the analysis to be perfect, but for the purposes of this article, I've kept it simple.

Not to my surprise, the analysis shows that there’s a direct correlation between R&D expenditures and market cap. I’ve kept the analysis focused on large-cap products and/or services companies mostly because both their internal operations and their stock prices are typically less volatile than smaller cap companies.

The list of companies and their ticker symbols are as follows:

Google: GOOG
Apple: AAPL
Microsoft: MSFT
Intel: INTC
Xerox: XRX
Oracle: ORCL
Cisco: CSCO
Caterpillar: CAT
Johnson & Johnson: JNJ
Dell: DELL

The following chart shows how these companies compare, and the black line is the trendline (generated by Excel):

Clearly, Apple and Google, have skewed the results here with their huge market cap per employee.  These two Wall Street darlings have clearly impressed the investors resulting in very high stock prices. You can also argue that they run a mean machine since they’re doing so much more “per employee” than the others, especially in Apple's case. And the amount of R&D funds Google spends per employee is mind boggling. It seems their entire operations are focused on R&D.

For the purposes of the analysis though, I removed the two anomalies so we can focus on more typical companies. The following chart compares the list sans Google and Apple: 

Now we get a more clear picture of the trendline. Looking on the lower left side, we can see that GE and DELL spend a pathetically low amount on R&D per employee. For companies with large manufacturing operations, this makes sense since that skews the numbers somewhat. But Dell’s last earnings results show that the company’s sales are still highly dependent on commoditized products, so maybe they need to rev up the R&D expenditures a little bit.

The next group is giant companies HP, IBM, Xerox, 3M, and Caterpillar. Without looking at the operations of each of these companies in detail, it’s really difficult to dissect the results, but I was a bit surprised to see IBM in the same category as Xerox. I admire so much that IBM does and I expected it to show up higher on the scale.

Microsoft sits high up on the top right. Software companies typically have higher R&D costs per employee, and given that Microsoft has had layoffs recently, the market cap per employee has also gone up. By the way, is anyone as surprised as I am about how much Johnson & Johnson spends on R&D? I'm not very familiar with the company's operations, but its position looks pretty respectable on this chart.

Based on this admittedly simplistic analysis, the main takeaway is that the lower right and the top left of the chart are completely empty, i.e., if a company spends a lot of money on R&D, their market cap 2-3 years down the line will not be very low, and vice versa (are you listening Mark Hurd?). Unfortunately, most public companies are forced into showing very short term results, so their CEOs constantly weigh the cost of R&D against their short term bottom line. I really wish I could do this on the entire S&P 500 group to see a better visual, but this took long enough.

Stay tuned for a similar analysis on the effect of R&D expenditures on revenues. I have a feeling the charts will look very similar.

As always, comments are welcome.


  1. What counts as an "employee" in this analysis? I would think that anyone in the list with a retail operation (or other low-skill high-number labor force) would get pulled down the graph. Dell still has large call-centers and other retailing labor force, no?

  2. The number of employees are the total number of employees from the annual reports. Yes, includes all the low wage employees as well.

  3. Dear Kat, thank you for a very insightful analysis. If you'll have a spare moment, would it be possible for you to make this analysis in respect to the key players in OIL and GAZ industry? Would be much appreciated!