Is Apple Inc. Under-Investing in Future Products?

By Markets Fool.com

Apple is the most valuable company in the world -- by a greater than 50% margin -- and it has delivered a total return of nearly 300% for shareholders in the past five years.

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AAPL Total Return Price Chart

AAPL 5-Year Total Return Price, data by YCharts.

Despite this phenomenal record of success, plenty of skeptics still like to second-guess Apple's management (or at least its post-Steve Jobs management). One frequent refrain is that Apple is underinvesting in itself as CEO Tim Cook has given in to Wall Street's desperate calls for stock buybacks.

Cook certainly has allocated a lot of money for dividends and share buybacks -- more than $130 billion between 2012 and 2015. However, the idea that Apple is underinvesting in research and development is simply a myth.

Proof of underinvestment?
Hedge fund manager Eric Jackson has been one prominent proponent of the "underinvestment" thesis recently. In a series of articles for Forbes, he argued that Cook has wasted the $100 billion that Apple has spent so far on dividends and share buybacks.

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Instead, Jackson asserted, Apple should have spent this money on a combination of research and development and acquisitions. Essentially, he believes Apple could grow significantly faster by spending more on R&D, while making strategic acquisitions would give the company access to new technical talent and further its long-term dominance.

Just this past week, Ophir Gottlieb of MarketWatch made a similar point. Gottlieb approached the question from a comparative standpoint. He noted that Apple spends less on R&D than either Google or Microsoft in nominal terms, and significantly less as a proportion of revenue.

On the other hand, he pointed to Apple's massive share repurchase activity of the past year. Gottlieb suggested that Apple would be better off spending more on R&D and returning less cash to shareholders.

The reality: rapid growth in R&D spending

These criticisms minimize both the absolute amount that Apple spends on research and development today, as well as the growth rate of its R&D spending. In its 2014 fiscal year, Apple spent $6.04 billion on R&D, up from $489 million just 10 years earlier.

AAPL Research and Development Expense (TTM) Chart

AAPL Research and Development Expense (TTM), data by YCharts.

As the chart above shows, Apple has been increasing its R&D spending at a steady rate (on the logarithmic scale shown, a straight line implies a constant growth rate). Over the full 2004-2014 period, Apple's R&D spending grew at a compound rate of more than 28%.

The case for more R&D is flimsy
Despite increasing R&D spending more than 12-fold in the past decade, it's true that Apple still spends less than Google and Microsoft. (In the last 4 quarters, those companies have spent $9.8 billion and $11.7 billion on R&D, respectively.)However, that doesn't necessarily mean Apple is skimping.

Jackson and Gottlieb both recognize -- in theory -- that more R&D spending isn't always better. Gottlieb mentioned that Apple has fewer product lines going than do Google and Microsoft, which could justify spending less on R&D. Jackson referenced a school of thought that R&D results can't necessarily be improved by having more resources.

However, neither pundit was willing to concede that these actually might be explanations and not just excuses. Apple has increased its R&D spending at least 30% each year for the past half-decade. Is it possible that it could productively spend even more? Yes -- but it's far from guaranteed. Just boosting spending 30% a year without wasting money seems challenging enough.

Similarly, to ignore Apple's focus on a few key products as a cause of relatively low R&D spending is also questionable. After all, the iPhone and iPad were developed in the mid-2000s when Apple was spending $1 billion or less annually on R&D.

The iPhone and iPad were developed on modest R&D budgets. Photo: The Motley Fool.

To say that Apple is spending too little on R&D by reference to what other tech companies are doing is essentially to assert that the iPhone and iPad were flukes. How could Apple have invented a $100 billion business on a sub-$1 billion R&D budget if there is a straight-line relationship between R&D spending and innovation?

Apple spends far more on R&D today than it did in its innovation heyday. That doesn't mean cutting back to $1 billion in annual R&D spending would help Apple to develop "the next iPhone". But it also highlights the danger of assuming that more R&D spending will lead to more or better results.

The article Is Apple Inc. Under-Investing in Future Products? originally appeared on Fool.com.

Adam Levine-Weinberg is long January 2016 $80 calls on Apple and short January 2016 $120 calls on Apple. The Motley Fool recommends Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.