Few fields move as rapidly as technology. Businesses creating outsized profits and returns for shareholders quickly get a bull's-eye painted on their back as they become targets of other companies looking to disrupt their products by selling cheaper alternatives that still prove "good enough." Not only that, but even if a company continues to dominate its particular field, other changes in technology can shift spending away from their products. Think about how Microsoft still dominates PCs but feels pressure from the sales shift toward mobile devices such as smartphones and tablets.

With that in mind, today we're looking at how Dell (Nasdaq: DELL) innovates. 

Technology companies can innovate either through acquisitions or by spending more money on research and development. We'll compare Dell's spending in these areas with that of its closest peers and assess whether the company is investing enough in its future.

Research and development
Over the past five years, Dell has spent an average of 1% of revenues on R&D. The following table summarizes how Dell's R&D expenditures relative to revenues compare with some of the company's closest peers.

Company

2006

2007

2008

2009

2010

LTM

Dell

0.9%

1.0%

1.1%

1.2%

1.1%

1.1%

IBM

4.6%

4.8%

5.3%

5.6%

5.4%

5.8%

Hewlett-Packard

3.9%

3.5%

3.0%

2.5%

2.3%

2.5%

Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years; yearly total is for company fiscal years closing in that period.

Dell clearly lags its key rivals in terms of R&D spending. This result is partially a function of Dell's core businesses; it's more focused on commodity PC sales, which require less R&D and are a low-margin sale. However, in recent years, Dell has been moving more into becoming a diversified IT vendor. As we'll see, acquisitions play a more important role in Dell's transformation.

Acquisitions 
In technology, some of the best companies have turned growth through acquisitions into an art. IBM has adeptly spun off capital-heavy businesses such as the hard-drive and PC segments, while it focused on acquiring additional services and software expertise that have transformed its business model.

On the opposite end of the spectrum, Hewlett-Packard is often criticized for underinvesting in R&D, to the point that it has to overpay on acquisitions to catch up with its competitors.

Investors should remember, most of all, that companies are valued by the cash flow they can bring in for their shareholders over time. If companies need to continue making purchases in perpetuity to keep growing, that amounts to a reduction in cash flows, and investors should treat acquisition spending as a continuing outflow against cash flow.

Let's take a look at Dell's free cash flow over the past five years against cash spent on acquisitions.

Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years; yearly total is for company fiscal years closing in that period.

Dell is a highly acquisitive company that has been ambitiously trying to grow its IT footprint since founder Michael Dell returned in 2007. Although the company tails its core competitors in IT spending, it's hoping to catch up using key acquisitions. In the past four years, Dell has bought Perot Systems to become more engrained in services and EqualLogic and Compellent to grow share in storage.

Final thoughts
Dell is in the midst of a major reorganization that should take several years to properly evaluate. I'm leery of the company's ability to fill in needs with piecemeal acquisitions in key growth areas such as storage, but I also think service and software acquisitions could assist Dell in offering value-added services over the long term. Dell isn't the best-positioned company for grabbing the next generation of computing growth, but it is attractively priced.

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Eric Bleeker owns shares of no companies listed above. The Motley Fool owns shares of IBM and Microsoft. Motley Fool newsletter services have recommended buying shares of and creating a diagonal call position in Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.