Companies That Slash R&D In Tough Times Hurt Shareholder Returns

In his latest column for The New York Times, Mark Hulbert discusses a study that shows that companies that invest aggressively in research and development tend to reward shareholders with strong returns over the long-term. He writes that ". . . when times are tough, beware of companies that cut their spending on research and development. The stock market tends to punish such businesses and reward those with a commitment to R.& D. — often years before long-term projects reap benefits."

But it’s very tempting for companies to slash R&D expenses when times are tough because it can provide a short-term jolt to earnings because it reduces expenses without reducing sales in the short-run. It often takes years for sales and earnings to reap the benefits of R&D investments so it’s always a tempting place to cut costs during lean times. But in the long run, that’s the exact opposite of what companies that build long-term value do.

It’s tempting to just think about this study in the context of research and development, but I think the ramifications are broader: companies that make major changes in their business model in response to the vicissitudes of the macroeconomic environment are often not making the decisions that drive long-term shareholder value. Last month some investors worried about that in the context of Whole Foods Market’s (WFMI) decision to try to attract more value-oriented shoppers, in spite of the premium price strategy that has driven its growth over the decades. And yet far too many companies make this mistake: banks lent aggressively when times were good and, now that the housing market has weakened, they’ve reined in their lending, perhaps too much.

When evaluating companies for investment, investors might do well to focus on companies that focus on long-term value, and are willing to put up with short-term earnings weakness in the pursuit of longer-term strategic goals. Because investors may punish these stocks for lower earnings, you might have a great opportunity to buy well-managed comanies at bargain prices.

Zac Bissonnette