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Ideas Farm: It's great to innovate

The pandemic has been a great advert for the pace of technological innovation, which should have implications for investors.
Ideas Farm: It's great to innovate
  • Vaccine brings innovation to the fore again
  • Can growth stocks stay ahead of expectations
  • Picks-and-shovels innovation plays can reduce the risk of backing the wrong horse
  • Loads of new idea-generating data

Heaps of positive vaccine news this month has been a boon for value investors. Unloved stocks and sectors have surged on the hope that life will become more normal next year. However, the vaccine developments themselves have really been an advert for the innovation trends that have underpinned the success of growth investing over the last decade.

The fact that positive results from three feasible vaccines are already on the table can be viewed as a triumph for drug development and the use of new technologies to hone in on the goal faster and more effectively than would have been possible in the past. And innovation is not only driving rapid progress in the field of health care.

For example, the Ark Disruptive Innovation ETF, which has more than doubled in value this year, lists four key disruptive innovation mega trends that it seeks to target: next generation internet; autonomous technology and robotics; genomics; and fintech. It further breaks out these areas into no less than 22 sub-themes including 3D printing, gene therapy, cryptocurrency and machine learning.

There is noteworthy momentum behind many of these developments, and many are in relatively early stages compared with the promise they offer. This is significant as the adoption of new technology, when it happens in earnest, can be rapid. This is often characterised by plodding early progress before a period of exponential growth, followed eventually by a plateauing. 

The pandemic has helped reveal and jump-start many of the early-stage innovations that have lurking in the shadows that could bring profound changes in the years ahead. For investors, there could be opportunities from backing innovators even at high valuations, while shares in companies left behind by disruptive shifts may ultimately prove expensive at any price.

The issue investors need to grapple with, though, is that historically bets on growth have often not paid off in the long-term. Rewind a decade to before growth began its recent run of outperformance, and one of the most compelling reasons given for the investment style’s historically disappointing returns was based on human behaviour. People’s brains are hardwired to believe in compelling narratives and also to extrapolate present successes into the future. This can result in assigning too much value to the prominent growth stories of the day. Many see this deep-rooted psychology as a reason for skepticism about the high valuations assigned to growth plays now, especially after the pandemic has provided many with an amazing shop window.  

However, there are alternative takes. The rate of innovation has generally accelerated throughout human history, and there are reasons to expect major technological developments in the years ahead - from AI to the “green revolution”. From a behavioural point of view, for growth to continue to deliver, “all” that is needed is for the rate of innovation to stay ahead of investors’ expectations.

The winners from innovation are never certain, and one decade’s growth darlings can fast become the next decade’s value plays. Both of the companies in this week’s tips section offer picks-and-shovels ways to play the innovation game. In a rapidly innovating world, the benefit of a picks-and-shovels play is that if they have a strong market position they can often prove more insulated from the cut and thrust of competition in the ultimate end markets.