Examining the R&D Line

It's not what you invent, it's what you invent and sell.

That would seem obvious, but when I look at the income statements of many of today's companies, I see a lot of money poured into research and development -- billions, in some cases.

But do I see returns on those dollars? That part is not so clear, especially for those of you who invest in research-heavy businesses like pharmaceutical, biotech and general technology. So listen up.

A recent Booz Allen Hamilton study found little real correlation between R&D investment and business performance. The only direct link was between R&D and gross margins relative to the industry.

The study went on to identify 94 of 1,000 companies that were "R&D efficient" -- but this list appeared to include many that just didn't spend much on R&D.

This study just didn't do it for me, though. How else do you bring R&D into the investing equation? It isn't easy, but I'll give it try.

R&D expenditure profiles typically fit a "barbell" model. On one hand, innovation-driven start-ups will spend a ton on R&D at the expense of profits -- probably a good idea.

On the other end, mature companies like Procter & Gamble (PG Quote) may spend a lot on R&D to stay on top of their game, which is OK if they do it well.

What gets me are those in the middle: companies that spend a lot and don't seem to get much for it.

Click here for the video version of this story from Jennifer Openshaw.

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