The Most Innovative Companies in the World all Have This in Common...

David Sterman's picture

Tuesday, August 9, 2011 - 11:00am

by David Sterman

Great companies know the key to future success lies in the steps you take today.

These companies dole out massive amounts of cash to their engineering teams to develop cutting-edge products that will provide for sales and profit growth in the years to come.

This strategy was the cornerstone for Microsoft (Nasdaq: MSFT) in the 1980s, Cisco Systems (Nasdaq: CSCO) in the 1990s and Apple (Nasdaq: AAPL) in the most recent decade.

But not all of this spending on research and development (R&D) pays off. Each of these high-tech companies has also had considerable flops. That's alright with management, though, because they know that taking risks is what yields success. And R&D efforts must have the freedom to aim high in search of new blockbuster products.

Merck (NYSE: MRK), Eli Lilly (NYSE: LLY), Bristol-Myers Squibb (NYSE: BMY) and Amgen (Nasdaq: AMGN) spent a collective $22 billion on R&D last year. Each firm aims to find the next blockbuster drug that can help to reverse the trend of anemic sales growth in recent years.

Pfizer (NYSE: PFE) set the industry tone. The drug company routinely generated more than $10 billion in sales for its cholesterol drug Lipitor (before it recently lost patent protection), and the drug has generated more than $60 billion in cumulative sales for the company, well ahead of the reported $3 billion it took to develop it. Of course, for every Lipitor, Pfizer also pursued dozens of drugs that never even made it to market.

If you're looking for a clear example of where R&D investments yield tangible benefits, check out Analog Devices (NYSE: ADI). The company makes a wide range of chips that go into cars, communication networks, industrial systems and a host of emerging technologies such as clean energy.

The company routinely spends nearly $500 million every year on R&D and now boasts amazing growth. Sales rose 37% in fiscal (October) 2010 and are expected to rise at another double-digit clip this year as well. When the global economy turns up, look for this company's strong investments in R&D to bear even more fruit.

Similarly aggressive investments in R&D are being made at chip maker Advanced Micro Devices (NYSE: AMD), which has badly lagged behind rival Intel (Nasdaq: INTC) in terms of hot new products. As I noted in July, AMD's big R&D push finally appears to be paying off.

Future-focused investors should also check out biotech firm Celgene (Nasdaq: CELG). The firm raised many eyebrows in 2010 by predicting sales would hit $8 billion and earnings per share would hit $8 by 2015. After all, the company generated just $3.6 billion in sales and earned $2.80 a share in 2010.

What is the company's strategic weapon? It spent a hefty 30% of 2010 sales on R&D to strengthen the company's pipeline of immune-suppression drugs.

Action to Take --> Despite the impressive commitment to future-oriented investments by these companies, they have been tarred and feathered along with many other stocks in this recent stock market pullback. This may be a good time to buy their shares.

For example, shares of Analog Devices have fallen more than 20% in the past three months on concerns the weak economy will crimp near-term growth. This may still be the case, but Analog Devices' long-term outlook has never been brighter.

In a similar vein, shares of Celgene are actually a bit lower than they were a year ago, even though the company's revenue base and profits have grown roughly 25% since then.

The key is to lock on to these long-term big spenders when their shares are being pressured by short-term concerns.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.