Investment in research and development (R&D) generates the new products, processes and services that can give a company an edge over its competitors. New products and processes that are patentable also provide a “moat” – an enduring competitive advantage – preventing the innovations resulting from R&D from being copied by rivals.
The amount a company invests in R&D is therefore a useful guide for investors seeking the most innovative companies likely to draw ahead of their competitors over the next few years. The extent of R&D at a company is known as R&D intensity, which is the ratio of investment in R&D to sales.
However, one cannot just compare the R&D intensities of different companies because the average intensity of different sectors varies markedly. R&D is a crucial factor in some sectors, such as pharmaceuticals, but of minor importance for others, such as mining or insurance.
The right approach is therefore to compare the R&D intensities of companies within the same sector and to do this only for industries where R&D is key. These R&D-intensive sectors are biotechnology; pharmaceuticals; software; technology hardware; health; electrical and electronic engineering; and aerospace and defence.
The average R&D intensity for biotech and pharmaceuticals is roughly 15%, between 9%-11% for software and hardware, and 5%-6% for health and electronics. Companies in the aerospace and defence and automotive sectors, meanwhile, have average intensities of 4%-5%.
