Do Patents Lead to Profits?

Common sense suggests that compiling a powerful portfolio of potent patents should produce perpetual profits. But according to a recent study, that's not always the case.

Last year, IBM (NYSE: IBM  ) extended its 17-year streak as the company with the most patents granted. But according to an Ocean Tomo study conducted for Bloomberg BusinessWeek, Microsoft's (Nasdaq: MSFT  ) smaller patent portfolio is 3.3 times more valuable than IBM's. Apparently, sheer volume of patents isn't enough.

According to the study, although IBM has been the patent king for many years, over the past five years, its collection's value is ranked only eighth in the world when it comes to "inventiveness." Microsoft ranks first.

Interestingly, the companies you might think of first as great innovators were ranked lower still, with 3M (NYSE: MMM  ) in 13th place and Apple (Nasdaq: AAPL  ) in 21st. You might not think of Hewlett-Packard (NYSE: HPQ  ) as more inventive than General Electric (NYSE: GE  ) , but HP is ranked fourth, compared to 23rd for General Electric.

Brother, can you spare a patent?
Patents are valuable for companies in many ways. Investments in research and development lead to new technologies that can then be used in new products, or licensed to other companies for a lucrative fee. The licensing of technology is a key revenue generator for Qualcomm (Nasdaq: QCOM  ) ; in November, Samsung announced that it would pay Qualcomm $1.3 billion for the right to use its cell-phone-related technology.

Innovation can be a powerful profit driver. Companies that break rules and devise new ways of doing things can create entire new industries. Apple has generated huge new business lines for itself (and other companies!) with its iPod, iPhone, and other products.

Quantity and quality
While it's instructive to note that the quality and profit-potential of patents is more important than their number, we shouldn't dismiss companies like IBM. A towering pile of patents opens up many possibilities for a company.

If you want to look for companies that can innovate and deliver big returns, keep an eye on their spending on research and development (R&D), along with your usual examined metrics. Just look for the R&D line item in the income statement, then divide it by total revenue, creating a ratio that you can compare against that of a company's rivals. Here's a quick look at several tech titans' recent research spending:

Company

R&D Spending

Total Revenue

R&D as a Percentage of Revenue

IBM

$5.8 billion

$95.8 billion

6.1%

Microsoft

$8.6 billion

$58.7 billion

14.7%

Apple

$1.4 billion

$46.7 billion

3.0%

Hewlett-Packard

$2.8 billion

$114.6 billion

2.4%

Qualcomm

$2.4 billion

$10.6 billion

22.6%

Source: Capital IQ, a division of Standard and Poor's. Figures are for trailing 12 months based on most recent financials.

Patents in perspective
Judging from the numbers above, the total amount you spend on R&D, and the percentage of revenue you spend on it, doesn't completely reflect your inventiveness. Look at Apple's seemingly low levels. Yet Qualcomm's high levels do indicate the importance to the company of R&D and its resulting patents.

As my colleague Anders Bylund found, "Companies with higher-than-average R&D spending also created above-average market returns for their investors." Perhaps that's why our team at the Motley Fool Rule Breakers newsletter has been known to look at "R&D efficiency" when they scour the market for potential blockbuster stocks.

If you want to examine a company's R&D spending more closely, look into how many new products or services it offers each year. A company may be spending generously on R&D, but if that's not translating into profitable results, it's a questionable expense.

What patent-rich companies are your favorite investments? Which do you think should spend more on R&D? Share your ideas in the comments box below.

Longtime Fool contributor Selena Maranjian owns shares of Apple, Microsoft, 3M, and General Electric. 3M and Microsoft are Motley Fool Inside Value picks. Apple is a Motley Fool Stock Advisor selection. Motley Fool Options has recommended a diagonal call position on Microsoft. Try any of our investing newsletters free for 30 days. The Motley Fool is Fools writing for Fools.


Read/Post Comments (3) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 09, 2010, at 10:54 AM, TMFSymington wrote:

    The first company I thought of when I saw this headline was Universal Display Corporation (PANL) with their more than 960 patents. My, oh my, how I would love to see some concrete financial progress from them by taking advantage of all that work...

  • Report this Comment On February 09, 2010, at 11:57 AM, MaxTheTerrible wrote:

    Working in Intellectual Property (IP) industry myself, I though I'd add my 2c worth. Patent portfolio can tell you a lot about the company. Unfortunately, as the author rightly noted, there is no magic IP metric that will tell you how good (or bad) the patents are.

    Being familiar with biotechnology and pharmaceutical industries I can tell you that evaluating patent portfolio for start-ups/ pipeline development companies is a must. I, personally, would never even think about investing with real money in such companies without DD on their IP position.

    Some companies with strong (IMHO) IP positions that I like are INCY and NBIX. INCY is one of the stars of my real life portfolio as the company recently announced several partnerships. Both companies are also picks in my CAPS portfolio.

    Strength of patent portfolio is an important metric but should not be used alone. Case in point - my NBIX pick in CAPS which is failing spectacularly. However, because of the IP position, I'm hopeful for an eventual buyout - that is IF the drug gets through clinical trials (that's a very big IF).

    Cheers!

  • Report this Comment On February 09, 2010, at 5:20 PM, kdt34wqx wrote:

    Guess what? Most GE R&D patents are issued to low and mid-level managers who want to appear productive. (They aren't.) Maybe that's why GE ranks so low in patent value!

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