Top 3 R&D-Driven Stocks Showing Strong Profit and Momentum

Key Points

• Research and development spending is a strong indicator of a company's commitment to staying technologically ahead of the curve.
• Companies with high R&D spending and high margins are positioned to maintain their competitive advantages.
• Making the software used to design advanced semiconductors is particularly R&D intensive.

When thinking about innovative companies that are trying fervently to stay ahead of the competition, research and development (R&D) spending is a key indicator of this ethos. Often quoted as a percentage of revenue, R&D spending is a driving force for many companies, especially those in the technology sector. Without it, businesses will eventually render their products inadequate as the competition provides greater value to their customers.

Strong R&D spending looks even better when combined with a company that is already profitable. It shows that they're able to make money and invest back into the business at the same time. Together, these two factors have a big influence on the long-term success of a business. Below, I’ll share three companies that are achieving both goals. Also, these stocks have seen recent price upticks, showing some momentum at the companies.

Cadence: A Leader in Chip-Making Software

Cadence Design Systems NASDAQ: CDNS is a maker of electronic design automation (EDA) software. EDA software is one of the most important tools needed to design advanced semiconductors. Without it, making the best chips is essentially impossible. It is a reason why the United States has banned U.S. companies from selling EDA software to Chinese firms.

As the world demands more and more advanced chips to run AI workloads and all the rest, Cadence must continue to make its software better as well. That’s why over the last 12 months, Cadence has spent 35% of its revenue on R&D. However, the company’s margins are also astounding. The company’s gross margin sits at nearly 88%, higher than 90% of companies in the United States. Its operating margin is also massive, coming in at just over 29%. That is higher than 93% of companies in the United States technology sector. Shares are on the rise as of late, up 11% over the last three months.

Electronic Sports: Outpacing Take-Two With Superior Margins

Electronic Arts NASDAQ: EA is a video game publishing, distribution, and development company. It has become widely known for some of its biggest game releases, including Madden NFL and The Sims. It is the largest video game company in the United States when leaving out the broadly diversified Microsoft NASDAQ: MSFT. The company dedicates a very large percentage of its revenue to R&D spending at 34%.

Customers continually expect better content in video games, especially the graphics. Creating better graphics requires investments in cutting-edge technology and skilled labor. EA’s R&D costs get driven further higher due to the nature of the games it makes. Significant amounts of the company’s revenue come from sports games like Madden EA College Football. Developers must release a new version of these games every year so they can update them with the real-life changes in teams.

Luckily for EA, it can support this spending due to its very high margins. Its 79% gross margin and 21% operating margin put it in an enviable position compared to most stocks in the U.S. communications sector. It is also handily beating out one of its main competitors, Take-Two Interactive NASDAQ: TTWO, on both those metrics. Take-Two has actually seen its operating margin drop to negative over the last few years. Shares of Electronic Arts are up 9% in the past three months.

Synopsys: Investing 32% in R&D

Synopsys NASDAQ: SNPS, like Cadence, is a maker of EDA software. Together, these companies control around 60% - 70% of the EDA market. Although the competition is much more even than between the two beverage businesses, the duopoly of Synopsys and Cadance pushes both of them to keep innovation at the forefront. The intense competition between these firms is shown in their R&D spending. Synopsys spends 32% of its revenue on R&D.

The company’s gross and operating margins are 81% and 23% over the last 12 months. They're not as good as Cadence's, but they are still impressive. This difference is somewhat reflected in the gap between the two firms' forward price-to-earnings (P/E) ratios. The number is at 45x for Cadence, compared to 40x for Synopsys. This signals that investors view Cadence's earnings as less risky than Synopsys’s, so they are willing to pay more for them. Shares of Synopsys have been up a solid 6% over the past three months. Wall Street sees decent upside in the stock over the next 12 months. The average price target implies shares could rise 14%.