After DeepSeek disruption, should tech investors back big R&D spenders?

Capital expenditure – or capex – had been the watchword for many investors ahead of this January’s tech earnings season.

The amount of cash the likes of Microsoft, Meta and Nvidia have splashed on tangible assets like property, buildings and equipment has been a key feature of the artificial intelligence arms race of recent years.

As in previous earnings seasons, even a slight miss on capex forecasts could have negative implications for share price – even when profits are booming.

UBS had forecast the ‘big four’ tech companies – Amazon, Apple, Facebook, and Google – to spend a combined $280billion during 2025 alone.

BlackRock expects spending on AI chips and data centres to surpass $700billion each year by 2030 – equivalent to over 2 per cent of US GDP – as ‘total spending across AI and energy infrastructure’ potentially approaching ‘industrial revolution levels’.

But that was before DeepSeek showed up.

The Chinese artificial intelligence challenger’s reemergence sparked an enormous market rout, as DeepSeek demonstrated it could deliver at a fraction of the cost and computing power of the US big tech behemoths –  upending all assumptions about the economics of AI.

Asset management giant Man Group said: ‘DeepSeek has discovered and openly shared a series of clever and novel techniques that drastically reduce the cost of training large AI models, and this will have a profound impact on the tech sector.

‘It’s been forced to turn to innovation given the constraints around chip supply they have had imposed on them.

‘This step-change in model efficiency suggests that we are likely to see a meaningful pause in AI capex, as the industry adjusts to the new reality.’

If capex is no longer the crucial indicator, for now at least, then investors may need to look to other metrics.

R&D and tech returns  

Less attention has been placed on research and development (R&D), which is generally considered operating expenditure – or opex – and covers costs associated with creating new products, services or processes through innovation.

Analysis conducted by Gerrit Smit, manager of the £2billionn Stonehage Fleming Global Best Ideas Equity fund, shows a ‘high correlation between R&D spending and share price performance’ over the longer term.

Google owner Alphabet’s R&D spending has risen 18 per cent on a compound annual basis over the last 10 years, according to the research. Its average return on invested capital (ROIC) over the period was 21 per cent, and it has produced a 19 per cent annualised return for shareholders.

Similarly, Amazon has delivered a total shareholder return (TSR) of 25.7 per cent over 10 years, with R&D growth of 25.8 per cent.

Semiconductor equipment giant ASML delivered a TSR of 27.2 per cent over 10 years, with R&D growing at a compound annual growth rate (CAGR) of 13.5 per cent and ROIC averaging 29 per cent.

And its not just the world’s biggest companies. Leading semiconductor-design software business Cadence Design Systems has seen its share price rise 31 per cent on a compound annual growth rate basis over the last decade with a net return of 34 per cent on its innovation spending.

Smit said: ‘In essence, businesses that earn high returns on capital are extremely attractive, particularly when they have ample opportunity to reinvest all the cash they generate at consistently high returns on that capital.

‘If a company can spend $30billion a year on R&D and another $45billion on capex – and achieve a 30 per cent return on that capital every year – it is going to grow very quickly.’

How does current ‘innovation spending’ stack up?

In its last financial year, Amazon spent $85.6billion on R&D, while Alphabet spent $45.4billion and Microsoft spent $29.5billion. The trio’s respective capex was $52.7billion, $44.5billion and $32.3billion.

Smit’s team added these figures together, adjusted out depreciation and amortization, and then calculated the sum as a percentage of sales for each company.

‘We believe this is a fair reflection of their innovation spending,’ he said.

Microsoft and Alphabet both made a net investment of 21 per cent in their last financial years, while Amazon invested 16 per cent of sales, according to the figures.

Microsoft boasts average innovation spending of 16 per cent of sales over the last decade, with average ROIC of 25.7 per cent.

Alphabet’s innovation spending has been 21 per cent of sales over last decade, with average ROIC 21 per cent.

Meanwhile, Amazon’s innovation spending has been 13 per cent of sales over last decade, with average ROIC 10.3 per cent.

Smit said: ‘If history is a guide, they should earn excellent returns on these investments.’