1. Business
January 13, 2022

Do innovative companies outperform their rivals?

By Verdict Staff

Technology is disrupting companies’ traditional business models and, in some cases, upending entire industries and sectors. Companies are responding to this challenge by building a more durable source of competitive advantage through innovation and building up intellectual property.

What role does innovation play in a success of a company?  To hear more please join a GlobalData Webinar on 20 Jan 2022, as we discuss how to use patents data to extract ‘Innovation Alpha’. Please register here for the London/US Region and here for the APAC Region.

There is evidence everywhere proving that disruption-led innovation trends have been accelerating over the last decade. Consider that the number of patent applications has rapidly grown over the last decade, at 10% compounded growth per annum – 1.5x times higher compared to the previous decade.

Company filing documents highlights ‘innovation’ as an important strategic focus area of corporate, with 14% compounded annual growth in ‘innovation’ as a focus area over last five years.

Companies are walking-the-talk on innovation too if you look at their patent filings. On average, during any given month, more than 50% of S&P 500 companies have a patent granted against their name.

These accelerating innovation trends are reflected in investors ascribing higher valuation to intangibles or intellectual properties. About 84% of S&P 500 market capitalisation is composed of intangible assets with intellectual property forming a major chunk.

Chart-1: Investors Ascribe Higher Value to Intangibles / Intellectual Property

However, are traditional methods of analysing companies using financial statements alone enough? Ignoring innovation potential of companies fails to ascertain its true value which means lots of missed investing opportunities.

GlobalData has analysed patent dataset to uncover innovative potential of companies. The research company has found that portfolio of most innovative companies handily beat the benchmark.

Additionally, such analysis is helpful in debunking common misconceptions like the notion that only technology companies are major innovators. GlobalData’s patent analysis revealed that companies from other sectors are also highly innovative. Consumer Staples and Industrials are two examples of sectors that are highly innovative.

Chart-2: Non-IT Sectors Also High On Innovation

Tangible benefits Using Innovation To Build Investment Portfolios

First, GlobalData’s Innovation Indices generates 3% to 8% Annualised Alpha over the S&P 500 over the last 6 years, with superior Sharpe and Information ratios.

We compute three innovation indexes using patents data:

  • GD Innovation Momentum Indicator: Volume based metric measuring the number of patents issued to a company. Captures the momentum/intensity in innovation. The higher the momentum, the higher the innovative potential.
  • GD Innovation Quality: Global Innovators: Measures how many countries or patenting authorities around the world the patent is registered in. Captures how global or local a company’s innovation is. The broader the geographic coverage, the more lucrative the monetisation potential.
  • GD Innovation Quality: Diversified Innovators: Measures how broadly the innovation is applicable, i.e., application in diverse areas (broad) or niche/specific areas (narrow). The more broadly applicable, the wider the opportunity set for monetising the innovation.

We measure outperformance in two ways for each indicator.

First, ALL portfolio, as can also been seen in the chart below, is portfolio of all innovative companies for each indicator, while Top portfolio in chart below refers to the top half of the ALL portfolio (top 50% of most innovative companies)

Chart-3: GlobalData Innovation Indexes Generate 3%-8% Alpha

Chart-4: GD Innovation Indexes Beat Specialist US-Innovation Indexes

[Note: ALL in chart above refers to GlobalData’s portfolio of all innovative companies, and Top in chart above refers to Top half of innovative companies from the ALL portfolio].

Compared to M-CAM Innovation α® US Index, GlobalData’s innovation indexes ‘Top’ portfolio’s (Top half of innovative companies) out-perform by 4% to 13%. And compared to NYSE R&D Innovation Index, GlobalData’s innovation indexes ‘Top’ portfolios out-perform by 1% to 2.5%.

This out-performance is important for investors who view innovation as a significant source of company’s value.

Third, the outperformance seen above has a fundamental driver. GlobalData’s innovation indexes provide access to companies which generate structurally higher future earnings predicated on innovation potential, ie., they are fundamentally well set-up to beat the benchmark.

Chart-5: Innovative Companies Have Structurally Superior Future Earnings Potential

Innovative companies have 2.2x higher future earning potential as innovation not only differentiates, but provides competitive edge to companies’ products and services, driving higher their future earnings potential whereas companies which don’t innovate witness sluggish future earnings growth.

Fourth, Innovative companies achieve sustainable and consistent out-performance over longer time periods. Investing in any one, three or five-year period in the last six years in GD innovation indexes resulted in out-performance more than 95% of the time.

In the 77 months from 2015-2021, there are 65 12-month periods, and GD Top Innovators Index in the table above outperforms in 62 of the 65 12-month periods, i.e., 95% of the time

Chart-6: Innovative Companies Generate Sustainable and Consistent Performance

In essence, out-performance from GD Innovation Index is not dependent on when you start to invest. They out-perform almost all the time regardless of the starting time chosen to invest.

This consistency in performance across time periods means they are fundamentally sound and immune to gyrations in the markets.

Finally, thematic tagging of GlobalData’s patents data allows thematic investors to bet on most innovative companies in particular themes like Artificial Intelligence, Electric Vehicle etc.

For example, GlobalData Artificial Intelligence (AI) Innovation Index, a selection of companies from the S&P 500 at the forefront of innovation in AI, generates 8.5% annualised alpha over the S&P 500. Such indices are available for 50+ technology themes.

Chart-7: Invest In Innovation In Preferred Themes

GlobalData enables Thematic Innovation Indexes for 50+ technology themes to cater to varied investors interests.

In summary, we believe GlobalData’s industry leading patents dataset should be of value to investors in analysing companies’ intellectual capital and innovation to assess its potential in not just navigating the complex maze of technology-led disruptions but to profit from it.

To understand more, please join our Webinar on 20-Jan-2022, as we discuss how to use patents data to extract ‘Innovation Alpha’. Please register here for the London/US Region and here for the APAC Region.