Posted inAnalysis

R&D is key to quantifying the value of firms

Companies that invest heavily in research and development often become “stronger for longer”.

This is the view of Hans Slob, senior portfolio manager at NN Investment Partners, who argues that well-targeted R&D investment enables these companies to gain a long-term competitive advantage.

The need for innovation has never been greater. In the digital age, new competitors emerge more quickly than ever before and product life cycles grow shorter.

As Slob points out, companies seeking to stay ahead of the game need a continuous stream of innovations that can help them sustain their growth rates and maintain their competitive advantages.

“Many studies have been carried out on the relationship between R&D and firm value,” he says. “Most of them show that R&D positively influences both stock returns and company value. In particular, studies have found that levels of R&D investment and growth in R&D investment are both positively linked to future returns.”

He adds that investment in R&D is a crucial element that drives companies’ long-term viability, as it reflects their intention to adapt to an evolving competitive landscape and stay ahead in it. “Well-allocated investments in R&D can lead to sustainable growth by generating new products and processes while also enhancing operating productivity,” Slob explains.

Sustainability

He also highlights the clear relationship between high levels of R&D investment and a stronger sustainability profile. And that solving the most pressing social and environmental problems will take a great deal of investment in sustainable solutions.

As a case in point, he namechecks Dutch semiconductor equipment company ASML. Rather than being a chip manufacturer itself, ASML provides the tools to chip manufacturers, and as the largest producer of front-end wafer equipment tools, it has one of the strongest positions in its value chain.

It is currently working on a stepper that will make wafers 60% more energy efficient.

“ASML is an example of a European company that has turned its R&D investments into a sustainable competitive advantage. Its biggest invention is its extreme ultraviolet (EUV) systems, which enable chip manufacturers to shrink their transistors to as small as five nanometers and even below – a revolutionary development.”

NNIP has invested in ASML in its’ Global and European Sustainable Equity funds.

According to Slob, ASML offers a textbook example of how continued and elevated R&D spending has driven innovation, undisputed market share leadership and sustainable value creation for all stakeholders – including chip manufacturers, suppliers, employees, and end users – over a very long period of time.

Andrei Kiselev, co-manager of the Aegon Global Sustainable Equity Fund, is another asset manager who focuses on companies using R&D to innovate and achieve competitive advantage.

“Our philosophy and process is to find disruptive growth companies that are addressing meaningful sustainability challenges. The last thing our investors would expect us to do, and the thing that would add least value for us, would be for us to tear up the rule book and suddenly go out there and look for deep value just because that is what is in favour in the market.” 

Kiselev namechecks Dynatrace as the kind of innovator he is looking for. “Engineers today can quite easily be overwhelmed by the amount of data they have to look at. Dynatrace has a cutting-edge product that helps engineers monitor the performance of their applications. It not only highlights performance pinch points and problems but also suggests proactive solutions and courses of action.”

European opportunities

Although high-growth R&D-intensive companies are much more concentrated in the US than in Europe, Slob maintains that Europe-focused investors can still find sustainable compounders if they look closely.

“A value chain approach is beneficial here: looking across the entire value chain, rather than just at individual sectors, to identify companies with strong potential for sustainable growth.”

Slob continues: “Certain subsectors in Europe offer more opportunities than others. As the frontrunner in renewable energy, Europe is home to Siemens Gamesa and Vestas, two leaders in onshore and offshore wind technology. The semiconductors and med-tech spaces have strong industry fundamentals and offer attractive opportunities that fit the criteria of being sustainable compounders. These contenders include Infineon, Philips and Siemens Healthineers.”

Whether businesses are US or European based, the key message from Slob is that companies that underinvest in R&D may save on costs, but at the expense of the future.