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Developing an Eye for R&D

How can investors play the market amid slower global growth? Credit Suisse suggests focusing on companies that spend heavily on research and development.

Despite the strong economic recovery in the U.S., nominal global GDP growth over the next few years is unlikely to reach the levels reached just prior to the global financial crisis. Developed economies grew an average of 5 percent between 1997 and 2007, while Credit Suisse estimates they will expand at an average of 3.9 percent between 2010 and 2019. As a result, it will be more of a challenge to find strong earnings growth in global equities markets. So how can investors play the market? Credit Suisse suggests focusing on companies that spend heavily on research and development.

Big R&D Spenders Outperform the Rest

Indeed, after being in decline for nearly two decades, R&D outlays are once again on the rise, and heavy spenders tend to outperform over time. Drawing on a database of 3,400 globally listed companies excluding financial and utilities firms, Credit Suisse calculates that total spending on R&D has risen from 1.9 percent of revenue in 2007 to 2.3 percent in 2013. And among that group, companies that spend more than 5 percent of revenues on R&D outperform global equities. Up to a point: those that spend more than 30 percent of revenues – Credit Suisse calls them "extreme R&D spenders" – do not. Momentum matters, too. The stocks of companies that have continually increased their levels of R&D spending have outperformed those reducing their commitment to R&D by some 7.5 percent a year over the past 10 years.

Best Returns in U.S., Canada, U.K., Denmark and Germany

What parts of the world see the most R&D spending? In a recent report entitled "Investing for Growth: The Innovators," Credit Suisse analysts Eugene Klerk and Richard Kersley point out that U.S. companies dominate a list of "high" R&D spenders, making up 65 percent of the total. Other countries with above average spending include Japan, the U.K., Taiwan and China. But some R&D spending is clearly more effective than others: Returns show significant dispersion at the country level, with companies in the U.S., Canada, the U.K., Denmark and Germany proving much more adept at getting a return on their R&D investment than those in Thailand, New Zealand, Israel, Italy and Spain

R&D Spending More Effective in Tech And Healthcare Sector

The same goes for sectors. R&D spending has proven a far more effective generator of return for companies in the technology, healthcare, and industrials sectors as it has in telecom and services. And within those winning sectors, basing stock picks on R&D spend can be a winning strategy. In healthcare, for example, selecting stocks based on their R&D profile has provided 3.5 percent of annual outperformance when compared to a portfolio of all healthcare stocks. Likewise technology, in which an R&D-focused portfolio has delivered almost 4 percent outperformance annually since 2000.

This article has been originally published in The Financialist.