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Buying back the future
June 19, 2006

The role of stock markets is to encourage investment in publicly held companies who can raise sufficient funds to undertake developments beyond the financial means of typical private companies or individuals. The companies in turn are supposed to undertake the research-and-development efforts that will yield successful products that will produce profits that can be shared among stockholders.

Unfortunately, this process is breaking down. USA Today, in "Some tech companies cut R&D budgets" (June 14, p. 1B), reports that R&D spending among high-tech firms listed on American, Nasdaq, and New York stock exchanges has fallen from 12.7% of revenue in 2001 to 10.4% is 2005. Companies making R&D cuts include Sun Microsystems, Hewlett-Packard, and Microsoft. In addition, Bell Labs is facing cuts even beyond the ones I commented on in my July 2003 Editor's Note due to the merger of its parent Lucent Technologies with Alcatel. And the US government is not stepping in to fill the gap left by corporate cuts.

And what are companies doing with the funds they might otherwise invest in R&D? In many cases, they are repurchasing their own stock, as the Wall Street Journal reports in "Big companies put record sums into buybacks" (June 12, p. A1).

Such buybacks benefit shareholders in that they increase earnings per share outstanding, at least in the short term, and not coincidentally they boost the earnings of CEOs whose compensation is tied to stock performance (although some CEOs do quite well despite poor stock performance).

Whatever their positive short-term effects, buybacks can presage a long slump. The Journal reports that Intel's stock has fallen 60% since a $4.6 billion buyback in 1999, although the company continues to pursue the strategy and repurchased $10 billion worth of shares in 2005--that at least represents a better bargain than the 1999 purchase.

Stock buyback programs can be effective in addressing share prices that don't adequately reflect company worth. But too often such a program is a declaration by a company that it is out of ideas, that it no longer knows how to innovate. Commenting on cuts in US R&D in the USA Today article, Kei Koizumi, a director of the American Association for the Advancement of Science, says, "It's not a good sign for the future innovation capacity of the US economy."

Who will make up that capacity? Sibling publication R&D Magazine (September 2005), in conjunction with Battelle, reports that while R&D spending will grow 6% in the US from 2004 to 2006, over the same period it will grow 28% in China.

Posted by Rick Nelson on June 19, 2006 | Comments (0)