2 Tech Companies Spending A Boatload On R&D
Since the start of 2012, the technology sector has been one of the best bets in a struggling global economy, returning 13.4 percent. In order to make bank from this trend, investors’ first inclination may be to hold a tech ETF or mutual fund, but there may be a better way to grasp the opportunities that lie in this sector. While it is always important to invest in companies with consistent earnings growth, quality cash flow generation, and attractive multiples, it’s also crucial to determine which demonstrate a clear commitment to research and development.
Because techies are truly innovation-driven operations, the only way to progress is through dollars-driven research. While earnings reports receive most of the noise in the financial press, tech investors must take note of the percentage of sales a company is spending on R&D. By determining which companies have a penchant for doing stuff like this, it is possible to outperform the broader market indices. If any of these firms are able to translate their research into tangible worth, you might even hit a home run, so to speak. Statistically speaking, multiple scholars – Aboody in 2000, Eberhart in 2002, and Chambers in 2002 – have found a positive correlation between high R&D spending and abnormal returns, so this isn’t just another financial fairytale. Below are two stocks that fit this mold quite nicely.
Ancestry.com (NASDAQ: ACOM)
As we discussed the other day, Ancestry.com has been a very good company to own in 2012; its stock has returned 21.9 percent year-to-date, and 100.7 percent over the past three years. Much of this growth can be attributed to the company’s otherworldly earnings growth, which has averaged 178.1 percent per annum post-recession. Going forward, this expansion is expected to slow down – analysts are forecasting a slight slowdown by the end of 2012 (25.4%), and 2013 (21.8%) – but double-digit growth is nothing to shake your head at. Not surprisingly, this for-profit genealogy researcher loves R&D, and has spent around 15 percent of its sales on it in the past twelve months. On the whole, this spending amounts to $61 million, a 69.4 percent growth since 2009.
Perfect World Co., Ltd. (NASDAQ: PWRD)
As one of China’s largest online gaming developers, Perfect World truly is bent on creating a perfect virtual world for its users. Presently, the company has six MMO games under its belt, with its most recent entry of War of the Immortals coming out of the gate with mixed success. Here’s the trailer; judge for yourself. From an investing standpoint, shares of PWRD have traded relatively flat in 2012, even though the company is trading at attractive Price-to-Earnings (3.5X) and Price-to-Cash Flow (2.8X) ratios. Looking toward the future, the company is siphoning nearly one-fourth of its total sales to R&D expenditures, a percentage that dwarfs competitors like Changyou.com (NASDAQ: CYOU) at 11.3%, Take-Two Interactive (NASDAQ: TTWO) at 7.7%, Activision Blizzard (NASDAQ: ATVI) at 14.0%, and Giant Interactive (NYSE: GA) at 13.2%.
It’s most important, though, is to measure how investors are valuing Perfect World’s devotion for R&D. To do this, we simply add R&D per share to earnings per share (a metric called growth flow), and compute what is known as the Price-to-Growth Flow ratio. Similar to P/E analysis, a lower P/GF ratio indicates that a particular stock is undervalued. When looking at the P/GF ratio of PWRD (3.3X), it is below CYOU (4.2X), TTWO (8.7X), ATVI (8.5X), and GA (6.1X). Perfect World also looks undervalued using the traditional price multiples, as it is trading at a discount of 50 to 75 percent below historical averages. WealthLift’s Sentiment Index also rates PWRD as a strong buy, with 83.33 percent of the community’s users placing an “overperform” rating on the stock.
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Disclosure: The author has no holdings in the stocks mentioned in this article and has no plans to initiate any positions within the next 72 hours. He does, however, have the intention of rating these stocks on WealthLift.com, a social media website where investment ideas are shared openly and free.
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