Profiting From Today's R&D Leaders

	Paul Tracy Street Authority.com
Special offer from StreetAuthority.com: Winning picks are up 242%, 189% and 135%. FREE Report--HIGH-GROWTH GAINS FROM LOW-TECH STOCKS.

Back in 1968 a Japanese electronics manufacturer called Busicom approached Ted Hoff with a calculator design. The design called for 12 separate circuits, each intended to handle one calculator function.

But Hoff didn't just manufacture the device Busicom asked for; instead, he simplified the calculator, creating a single programmable memory chip that could handle all the functions of Busicom's original design.

And so, the microprocessor was born and the company Ted Hoff worked for, Intel Corporation (INTC), refined the basic design to create the Intel 4004 processor. That calculator marked the first in a long line of processors that would make Intel a world leader in computing and, eventually, one of the best-performing stocks in U.S. history.

Fortunately, Intel isn't unique. Rather, the company shares a common feature with many of the best-performing, most profitable stocks of all time: a history of innovation.

Low labor costs, cheap materials and even clever marketing campaigns can boost sales and profits temporarily. But over time, all of these can be easily copied and emulated by a firm's competitors. Real long-term advantage comes from inventing something new -- creating a new product or feature that consumers simply must have and then maintaining that lead by constantly improving upon that product.

This type of advantage doesn't come cheap. Often times, the best-performing company in an industry is the one that spends the most on research and development (R&D). Intel, for example, spent billions of dollars on research and development (R&D) to become a world leader in microprocessors. And the company remains a leader in R&D spending today, shelling out close to $5 billion year -- 13.5% of annual sales -- on research. Over time, this enormous investment has been well worth the effort -- Intel has enjoyed high profit margins and a defensible competitive advantage for years.

On a broader scale, consider that the U.S. remains either top dog or at least a prime competitor in most of the world's key industries. However, the U.S. certainly doesn't have the world's lowest labor costs, nor does our nation have access to the cheapest natural resources. But American firms have an important advantage: they've traditionally been big innovators, spending more than most foreign competitors on R&D.

As you can see in my chart, this spending has resulted in higher profitability. U.S. firms spend 4.9% of sales on R&D, and partly as a result of this, they deliver average profits of 10.3% of sales. By contrast, EU firms spend 3.6% on R&D, and profits for firms in the Union average just 6.8%.

But this isn't the only example of the power of research and development. Over time, a number of academic studies have shown that, all other things being equal, firms that spend big on R&D tend to outperform their peers.

With this in mind, my staff and I spent countless hours pouring over our extensive database of companies, looking for firms that have spent heavily on R&D. More specifically, we searched for companies with enterprise values of more than $200 million that spend more than 15% of their annual sales on R&D. We then further refined and culled the list based on a variety of fundamental criteria.

In the table below, I present a list of R&D heavyweights. And in the text that follows I'll examine nine companies that are making the investments necessary to remain at the forefront of their respective industry groups. Thanks to their unwavering commitment to innovation, all nine of these firm look like solid long-term investments.

Adobe/Macromedia (ADBE)
Adobe is the world leader in design, image and desktop publishing software. The company's suite of products includes the ubiquitous Adobe Acrobat software, which is used to publish documents online. The free version of Acrobat, which is used to read (but not create) documents, has been downloaded over 500 million times, testament to the fact that it's one of the most common and popular electronic publishing formats in the world today. In addition to Acrobat, the company also makes Photoshop for manipulating images and Creative Suite, a graphics design package.

Recently, Adobe agreed to purchase Macromedia. Macromedia is the maker of the popular Flash software used to create web site animation and graphics. And the company also makes the wildly popular Dreamweaver web site design and content management software.

Adobe spends roughly 19% of its annual sales on R&D. The company has consistently innovated new features for its software that have helped it to maintain market share. This includes more user-friendly interfaces for its web site design software to a make it easier for small businesses to set up web sites. In addition, Adobe has also more closely integrated its various products so it's simpler to manage content across multiple Adobe products.

Amgen (AMGN)
Amgen is one of the largest and most successful biotechnology companies in the U.S. The company relies on three core products for most of its revenues right now: Epogen/Aranesp, Neulasta and Enbrel.

Epogen and Aranesp are drugs used to treat anemia -- lower-than-normal red blood cell count -- caused by chemotherapy or kidney disease. Neulasta is designed to stimulate the immune system in cancer patients. And finally, Enbrel is used to treat rheumatoid arthritis. All three drugs are considered blockbusters and all are highly profitable for Amgen.

If there's one industry where R&D spending is indispensable, it's pharmaceuticals. Drugs lose their patent protection after a certain period, and at that point in time they are subject to generic competition, which erodes profit margins quickly. As a result, pharmaceutical and biotechnology companies constantly need to discover and develop new drugs in order to earn above-average profits.

Amgen plows nearly 20% of its sales into R&D. The result has been a steady stream of promising new drug candidates in recent years, including an osteoporosis -- a brittle bone condition common in older women -- drug, as well as a drug for treating colon cancer.

Amylin Pharmaceuticals (AMLN)
Amylin Pharmaceuticals is a biopharmaceutical company with two new drugs on the market, Byetta and Symlin. Both are treatments for diabetes -- Byetta is designed to treat diabetics who aren't dependent on insulin, while Symlin is aimed at patients who are also taking insulin injections. Rising obesity in America is one of the factors that has led to an explosion in diabetes patients over the past few years. Overall, diabetes is a $140 billion drug market that accounts for about one-tenth of all money spent on pharmaceuticals every year.

Amylin is still a relatively small company with a market capitalization of around $2 billion and annual sales of just $35 million. However, the company spends more than 350% of its current sales on R&D. In addition, AMLN has partnered with major pharmaceutical companies -- most notably Eli Lilly (LLY) -- on recent deals in an effort to leverage its R&D dollars even further.

Amylin now boasts several promising drugs in its pipeline. Chief among these is a slow-release version of Byetta that will enable patients to take less frequent injections and get the same effect.

Avid Technology (AVID)
Avid Technology makes the software and systems used to edit videotape and motion picture films, as well as software to create special effects for films. Although the company faces some competition in this market, Avid is far and away the market leader in the film editing business. In fact, 90% of primetime television shows and more than 80% of feature films and commercials are edited or enhanced using AVID technology.

The film and TV business is not static. Anyone who has watched a feature film in recent years knows that there have been major improvements in special effects to make the movie experience more realistic. AVID spends about 16% of its annual revenues on R&D. The company pioneered three-dimensional animation effects and is now a leader in software used by videogame developers to create graphics. The company's large R&D budget should allow it to maintain its leadership position in the video editing market for years to come.

Biogen IDEC (BIIB)
Biogen IDEC is a biotechnology company with two primary drugs on the market. These include Rituxan for non-Hodgkin's lymphoma, as well as the blockbuster Avonex -- the top-selling multiple sclerosis drug on the market today.

Biogen IDEC also has the third-largest R&D budget in the biotech industry, spending a whopping 31% of its sales on R&D. The company has two drugs in the latter stages of development and a very full pipeline of drugs still in early stage testing. One of the later-stage candidates is Amevive for psoriasis -- a common skin disorder. Another is a follow-up drug to Rituxan for the treatment of lymphoma. Meanwhile, the company's early stage pipeline includes drugs for congestive heart failure and cancer.

Electronic Arts (ERTS)
Electronic Arts is the largest player in the videogame publishing industry. In fact, the company publishes about 3X as many major titles -- titles that sell more than one million copies per year -- when compared to its nearest competitor, Activision. And Electronic Arts is significantly larger than any of its rivals when looked at in terms of sales, operating income, enterprise value and a host of other factors.

ERTS currently spends about 20% of sales on R&D. The videogame market is a very creative business. It's important for ERTS to spend money to develop new games with realistic graphics that will attract gamers. And in more recent years the company has also spent considerable cash to develop online games that allow many players all over the world to compete. Not only are these advanced games proving to be highly popular, but they also eliminate the piracy problem that is starting to plague the gaming industry.

Genentech (DNA)
Genentech is the second-largest biotech company in the United States. Until 2003, DNA had just two cancer treatments on the market. But over the past couple of years, Genentech has delivered a long string of highly successful drugs and its pipeline has truly blossomed.

Topping the list of blockbusters is Avastin, already approved for colon cancer and now being tested on other indications. Most analysts believe this drug will be worth more $2 billion in annual sales by the end of the decade. Also on the market is Tarceva, a drug approved for lung cancer.

Genentech still spends more than 20% of annual revenues on R&D. That spending has helped to fill out Genentech's latter stage pipeline -- several new drugs for cancer, psoriasis and other diseases are now in late-stage trials. DNA has also been stretching its R&D dollars even further by partnering with other drug companies to develop new pharmaceuticals.

ImClone Systems (IMCL)
ImClone is a biotech company with a single product currently on the market -- Erbitux for second-line treatment of colon cancer. Second-line treatment means that the drug is only used after other drugs have been tried. IMCL is also testing Erbitux for use in treating other cancers and as a first-line cancer treatment.

ImClone spends 20% of annual revenues on new drug development. Although the firm does not have many new drugs on the immediate horizon, ImClone has developed and patented several proteins of the same class as used to create Erbitux. Interestingly, the basic chemistry is the same as that used by Genentech to create Avastin -- possibly the most promising cancer drug to hit the market in more than a decade. These proteins could form the basis for several promising new drugs in the future.

Texas Instruments (TXN)
Texas Instruments is the market leader when it comes to a particularly fast-growing segment of the semiconductor chip market -- analog and digital signal processors (DSPs). DSPs are in most mobile telephone handsets and are behind much of the functionality these phones offer. And as we all know, mobile handsets are one of the most popular consumer electronic products in the world today.

More advanced DSP chips are used in so-called 3G phones -- phones that offer high-speed data services -- enabling TXN to grab an early lead in these high-margin handsets. And outside the mobile phone market, DSPs form the guts of other key products, such as digital cameras and music players.

Mobile phones are constantly becoming more technologically advanced. A few years ago, most phones simply allowed basic calling and text messaging. Nowadays, however, many phones integrate cameras, music players, Internet and even basic spreadsheet and word processing software. Clearly, all these features demand more advanced chips, and many of these are being made by Texas Instruments. TXN has maintained its 50% market share in DSPs by constantly innovating more advanced chips that can handle the new features on modern phones.

----------------------------

I sincerely hope you've enjoyed today's look at several companies that should outperform their peers thanks to heavy spending on R&D. Please stay tuned for my next full issue, which I'll publish on Monday, August 29th. In it, my staff and I will examine a way for you to dramatically lower your tax burden by investing in dividend-paying stocks that offer tax-free distributions. Good investing in the week ahead!

Paul Tracy will be available to take your questions until Monday, August 22. Please use the form below to submit your questions.