R&D All-Stars: The CNBC RQ 50

R&D all-stars every value investor needs to know about


For value investors, finding a predictive tool that can help locate stocks that offer long-term opportunity based on their proprietary growth strategy is sacrosanct. That's because few exist.

Recognizing the problem, CNBC partnered with Washington University in St. Louis business school professor Anne Marie Knott, who specializes in innovation, to develop a list of publicly-held U.S. companies investing $100 million or more in R&D. We then ranked their research quotient (RQ): the measure of R&D productivity that links R&D spending to corporate revenue growth and market value. Companies are ranked based on ability to increase revenue from R&D, not the absolute dollar value of projected revenue increase.

The R&D All-Stars: CNBC RQ 50 is the first of its kind. It calculates the percentage increase in revenues associated with a 1 percent increase in R&D.

YanLev | iStock / 360 | Getty Images

What the list reveals is that spending more on R&D does not necessarily generate higher returns. This allows investors to identify firms that fall below other innovation measures' radar. This is why an RQ portfolio consistently outperforms the market. In addition, RQ allows investors to anticipate the impact of increased R&D on future stock price.

To develop the 2014 R&D All-Stars: CNBC RQ 50, we combined the 2013 fiscal year financial data—including revenues, property, plant and equipment, advertising budgets and R&D investments—for all 5,998 public U.S. companies for the last eight years (2006 through 2013). To find R&D leaders, we winnowed our universe to companies that were not acquired or divested, and those that did not outsource this function during this period. Then we ranked the remaining firms in descending order of RQ to come up with the top 50.

The companies on the list represent a wide swath of the U.S. economy. The industry sector with the highest RQ is electronics (20 percent); followed by computer software/services and pharmaceuticals (both 14 percent); computer storage (10 percent); medical instruments and communication equipment (both 6 percent); petroleum and industrial chemicals (both 4 percent); and others (22 percent).

There are key differences to RQ over other measures of innovation. First, it's transparent—you can estimate it yourself if you have the full set of firms' financial data. Second, it's universal, and you can construct it for any firm doing R&D (whereas you can't count patents for the 50 percent of firms who don't patent their R&D).

Third, it's uniform—since it's unitless (essentially a ratio of revenues/R&D), you can compare firms regardless of the type of R&D they do (many of the RQ 50 firms are overlooked by other innovation rankings because they do process R&D—which isn't as visible as product R&D).

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According to Knott, who has been tracking RQ using data going back 40 years, there are a few common traits among companies with high RQ share. "Most are strategic and put innovation front and center in their organizations," said Knott, who is a professor of strategy at the Olin Business School at Washington University. "These firms tend to have centralized R&D, and they fund it consistently," she noted.

Just as important, they are ahead of technology trends and are able to anticipate market shifts to exploit niche opportunities. Since they tend to have large market shares, they have pricing power in the market, so they can often diffuse innovations at a lower cost than rivals, Knott said.

The findings lend additional evidence that R&D's role as an engine of growth is as important as ever. And it creates great value for shareholders that few can ignore.

—By Lori Ioannou, senior editor, CNBC.com

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