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

HP: HPQ

IBM: IBM

3M: MMM

Intel: INTC

Xerox: XRX

Oracle: ORCL

Cisco: CSCO

Caterpillar: CAT

GE: GE

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.

HP’s board, CEO Mark Hurd’s resignation, and the morality police circus in Corporate America

Corporate America has done it again. They pulled out their “morality” card and managed to topple one of the most powerful tech executives in the country. If you don’t know about HP CEO Mark Hurd’s resignation by now, I won’t get into details, just google “Mark Hurd resignation” and you’ll get thousands of links to the story. In short, Mark Hurd resigned abruptly late last week after investigations into a sexual harassment suit revealed that he had tweaked his expense accounts to hide the woman’s name.

I’m no big fan of Mark Hurd’s. I’ve been on the record criticizing him when it came to light that he was severely cutting back on HP’s R&D activities, and later again when he mocked cloud computing. But this?!

Granted, whenever you find sex, money, and power mingled together, you’re bound to have a good story. I intentionally waited a few days for more news to come down the pipelines before writing about this, but nothing new is coming out on the story.

From all the articles I’ve read, it’s clear Hurd did nothing illegal. HP is in no way compromised legally or monetarily. Hurd didn’t spend lavishly on this woman (he offered to pay any money owed HP, which was a few thousand dollars). They both deny any physical relationship. And he personally settled the case with the woman in question prior to his forced resignation.

So why was the HP board so adamant to let him go? It’s the case of morality policing that’s all too present within Corporate America. They didn’t like the fact that he hid the name of this woman he hung out with, and possibly had a crush on. Here’s the question: if he tweaked other information that had nothing to do with a male/female relationship, would they have forced him to resign? Highly unlikely, they'd probably give him a wrist slap, rightfully so. But, oh, there was a woman involved and he had to resign.

This is nothing new.

Back in 2005, Boeing forced its new (and very promising) CEO to resign after the board was tipped off about an affair he was having with a company employee who didn’t directly report to him. No joke. They didn’t want the CEO to have a consensual affair.

A few years back I worked with a small public company struggling to increase sales. The company’s top sales executive was costing the company about 2-3 pennies a share every quarter from his total compensation and travel expenses. If you follow stocks and earnings reports, you know that’s huge. They didn’t fire him for his lackluster performance or his ridiculously lavish travel expenses. They fired him because they didn’t like that he was having an affair.

So back to Hurd.

The board didn’t mind that he practically decimated the R&D organization at HP (he was even on record making fun of the R&D folks).

The board didn’t mind that he acquired Palm, the bottom-of-the-totem-pole mobile player on the brink of bancruptcy, for a staggering $1.2 billion in cash.

No that was OK. But they didn’t like that he had a crush on this woman and wanted to hide it.

Here’s what I have to say to these boards. How about you focus on the CEO’s strategies, leadership qualities, and overall performance and let the wives slap them across the face for cheating on them? It’s much more their business than yours.

The first trading day after Hurd's resignation, HP's stock dropped 10% on almost 10 times the average volume. The board is lucky the damages weren't worse.

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And now that we’re moving on from Hurd, I think it’s high time HP promotes Anne Livermore to the CEO post. She’s a long time insider who was passed up in favor of Carly Fiorina back when the company was focused on hiring an outsider. She’s responsible for almost half the company’s revenues, and the most strategic businesses within HP (storage, servers, software, and services), and she’s probably the only person who has enough internal insight and operational capability to continue with the integration of the slew of HP’s recent acquisitions. Go Anne!