Apple Is Spending ‘Dramatically Below Peers’ on Innovation – Barron’s

R&D growth has outstripped revenue growth by a factor of three since 2012, and now amounts to 7% of revenue.

Apple
has long been an icon of American innovation. The iPhone, Mac, iPad, AirPods and other innovations have contributed to the company’s nearly $2 trillion market valuation, making it America’s most-valued company by a wide margin.

But Bernstein analyst Toni Sacconaghi asserts that Apple (ticker: AAPL) is underspending on innovation relative to its peers. And it likewise is spending far less than rivals on the acquisition of new technology developed by others.

Sacconaghi points out in a research note on Tuesday that Apple was spending just 2.2% of revenue on research and development, “dramatically below peers,” when CEO Tim Cook succeeded Steve Jobs in 2011. It has been moving aggressively to catch up ever since.

R&D growth has outstripped revenue growth by a factor of three since 2012, and now amounts to 7% of revenue. But Sacconaghi says that Apple, nonetheless, continues to underspend peers and he thinks comparisons with rivals argue for spending 10% or more of sales on research and development.

Meanwhile, he notes that Apple has spent just 2% of free cash flow on mergers and acquisitions since 2012, versus the 25% of free cash that peers spent on deals. He notes that in the period from 2012 through 2019, Apple generated $436 billion in free cash flow, and spent just $6.9 billion on deals, choosing instead to return most of that to shareholders in the form of buybacks and dividends.

“While share repurchases have historically been an effective use of cash and enabled Apple to grow EPS, we worry about potential parallels with
IBM,
who we believe underspent on innovation and overspent on buybacks, when it should have been reinventing itself amidst slowing product and services growth as computing moved off premise,” Sacconaghi writes.

“The combination of low R&D spending and low M&A suggests that Apple may still be ‘underinvesting’ in innovation versus its peers,” he writes. “We continue to believe that Apple making large acquisitions is unlikely. Could the recent surge in Apple’s R&D spending presage new product innovation? Hard to say. On the one hand, we see potential in the sheer magnitude of Apple’s spending ($60 billion over the last 5 years) and the company’s focus on potential new categories,” citing autonomous driving and augmented reality.

On the other hand,” the Bernstein analyst says, “Apple’s R&D budget last year alone ($16 billion) was greater than its cumulative R&D spend from 1999 to 2012, and yet the pace of new product introductions doesn’t appear to have accelerated.

Sacconaghi maintains a Market Perform rating on Apple shares. “On the one hand, we find it somewhat difficult to see much upside to Apple’s valuation on a long-term basis. On the other hand, we believe the stock is now more or less ‘de-risked’ on a near-term basis. Apple’s stock has historically fared well in advance of new iPhone launches and sell-side expectations for the September 2021 fiscal year still look beatable.”

Apple, as a matter or policy, declines to comment on analyst notes.

The stock rose 0.8% to $462.25 on Tuesday. The
Dow Jones Industrial Average
fell 0.2%.