#-ad_banner-#For some investors, the current bull market has dubious underpinnings. That’s because “financial engineering,” where firms pour cash into oversized share repurchase and dividend payment programs, are creating an artificial boost to core growth rates.

Yet such moves often means sacrificing equipment upgrades, product development and other crucial long-term investments. Sooner or later, firms that underinvest in their businesses risk serious underperformance.

That’s why I seek innovators with a demonstrated commitment to research and development. These firms tend to display the solid, consistent organic growth necessary to evolve into an Apple, Inc. (Nasdaq: AAPL) or 3M Co. (NYSE: MMM).

Along with these stalwarts, one of my favorite firms using R&D to generate strong organic growth is Autoliv, Inc. (NYSE: ALV), a mid-size auto safety products maker with annual sales of $9.1 billion.

Autoliv doesn’t neglect dividends and share repurchases, but keeps such efforts in check. At this firm, innovation is a top priority, which has been rewarded by investors with a nearly 100% gain during the past three years, far outpacing the S&P 500’s roughly 50% gain.

Founded more than six decades ago, Sweden’s Autoliv is the leading provider of “passive” auto safety products (mainly seatbelts and airbags), with a 37% global market share. The company sold its first seatbelt in 1956 and invented the first side-impact airbag in 1994 to Volvo (OTC: VOLVY). Today, its customers include every major auto manufacturer.

As a percentage of sales, Autoliv’s R&D budgets rival those of 3M, a company renowned for its culture of innovation. Since 2005, R&D has averaged 5.3% of sales, not far behind 3M’s 5.7%.

One of Autoliv’s most recent innovations is the bag-in-belt, a combination device with a small airbag running the length of the seatbelt shoulder strap. The airbag provides extra protection in an accident by tripling the surface area of the shoulder strap, thus better distributing crash force. Bag-in-belt debuted a couple years ago in Mercedes-Benz S-class sedans. Such new technologies will eventually trickle down to lower-priced cars.

For Volvo, the company developed exterior, hood-mounted airbags designed to cushion the blow to pedestrians or cyclists that are accidentally struck by the vehicle. Other innovations include anti-whiplash systems, knee-level airbags and integrated child seats.

The passive safety market accounts for the lion’s share of the company’s sales, which rose nearly 80% in the past five years. About 70% of these sales come from Europe and other foreign markets.

That means Autoliv is squarely in the path of the strong dollar, which drove first-quarter sales and earnings per share declines of nearly 6% and 22%, respectively (though earnings still beat expectations by about 8%). Shareholders can expect currency headwinds to impede results this quarter, too, management warns. 

However, the silver lining was 4% organic growth in sales, after adjusting for the impact of currency exchange rates. The adjusted operating margin was nearly 9%. Management reiterated its full-year forecast for 6% organic sales growth and an adjusted operating margin of nearly 10% — comparable to last year’s results of 6% and 9%, respectively.

Autoliv is seeing especially strong organic growth in “active” auto safety, a small, but fast-expanding, segment focusing on accident prevention technologies. (By contrast, passive safety features protect vehicle occupants once an accident occurs.) The contribution of active safety is expected to roughly double to 10% of total sales within two years.

Among the segment’s products are automatic forward collision warning and braking, lane departure warning, night vision and pedestrian detection. The company has also developed an “active seatbelt” that tightens automatically if sensors within the vehicle show an accident is imminent.

The goal is to diversify the segment as much as possible to capitalize on a highly fragmented market. With a broad product portfolio, it’ll be easier to dominate as the active safety industry balloons to an estimated $2.8 billion by 2016 from $1.3 billion in two years prior, management says.

A serious misstep by Japanese rival Takata Corp. (OTC: TKTDY) should enable the company to boost sales in its passive safety segment too. Along with 10 major auto makers, Takata is mired in a recall of 17 million vehicles with potentially defective Takata airbags.

The recall is related to reports of exploding airbags that spray metal shards upon deployment, a defect that has been linked to six deaths and more than 100 injuries so far. Though unfortunate, the problem enables Autoliv to position itself as a safer option, since no such issue has been reported in its airbags. Honda Motor Co. (NYSE: HMC), Takata’s biggest customer, has already turned to Autoliv for replacement parts needed to repair defective Takata airbags.

Risks To Consider: As a participant in the highly cyclical auto industry, Autoliv commonly displays substantial earnings volatility. Thus, its stock can show great price variability at times, as well.

Action To Take –> Avoid stocks that rely heavily on financial engineering for performance. When it comes time to pay the piper, shareholders will suffer. Instead, stick with firms like Autoliv, an innovator showing the strong organic growth necessary to gain further market share.

The company’s revenue growth should be most robust in emerging markets, where the auto industry and consumer demand for auto safety features are booming. Opportunities should also remain plentiful in North America and Europe. There, safety standards increasingly require active safety features for a five-star crash rating. The trend could easily spill over into emerging markets.

With such bright prospects, Autoliv should compound earnings by 9% annually, perhaps even somewhat faster as the dollar loses strength (it’s currently about 5% off the all-time high). I estimate 50%-to-60% upside potential for the company’s stock during the next five years.

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