Part 1

Investing in innovation provides opportunities for alpha returns but the challenge for investors is to identify investible opportunities in innovations that have the potential to sustainably change our world in a sustainable way. We envision 9 key themes here that have the most potential to grow exponentially, bringing along significant economic benefits to companies that produce and use them. Undeniably, the Internet of Things, machine learning and artificial intelligence are showing enormous ability to transform our world and are just some examples of innovation within Big Data and Analytics. Gene sequencing and neurochemistry are providing innovations in healthcare which have the promise to radically improve our quality of life. However, innovation is not limited to the tech and healthcare sectors. Themes like Nanotechnology, Energy Systems, Robotics and 3-D printing have wide-spread application across other sectors as well.

To address this challenge, Morningstar has created a robust framework to identify innovative companies employing a fundamental and bottom-up approach. Using a systematic approach and relying on the deep understanding of each company’s fundamentals of over 100 equity analysts, Morningstar has assessed each company’s (over 1400 companies under coverage) exposures to the 9 key themes in innovation.

Based on Morningstar’s framework, we find that innovation transcends the technology sector and other sectors such as healthcare, financial services, industrial, consumer cyclical and communication services representing over 60% of the leaders in innovation. Additionally, we screened our coverage for leaders with attractive valuations and highlight the following: Amazon (AMZN US), General Electric (GE US), Qualcomm Inc (QCOM US), Roche (ROG VX) and Vodafone (VOD LN).

Changing the World with Innovation and Exponential Growth

Technology has the power to radically change our behaviors and everyday lives. Yet it’s not only how rapidly technologies develop, but how they interact to catalyze growth that magnifies their impact. The concept of exponential technologies has its roots in Moore’s Law and Kurzweil’s Law of Accelerating Returns which broadens upon the idea of exponential growth to all forms of technology as a continuation of biological evolution.

Technology Adoption Life Cycle – “Crossing the Chasm”

The technology adoption life cycle models how different groups in the world’s population begin to use new technologies. A technology can’t become exponential unless it builds momentum as it makes the transition from a curiosity used only by the earliest of adopters to a mainstream advance accepted by the majority (“crossing the chasm”). The larger the market is, the greater the potential economic impact—yet the right conditions and infrastructure must exist to accelerate change. Personal computers began to make their way into millions of businesses, homes, and schools in the early 1980s—fundamentally changing how we work, play, and learn today. IBM was one of the companies responsible for compressing a machine that once cost millions and occupied a quarter-acre-sized room into something that fit on a desktop and cost roughly the same price as a diamond engagement ring in its day. This would not have happened without the development of the micro-processor in the 1970s, which made it possible to reduce both the size and cost of a computer so an ordinary person could own one.

Investing early in transformational technologies is an opportunity to build substantial wealth. Those who bought shares of IBM in 1924 for $27.50 would have made many multiples on their original investments. In a world of technology changes and globalization, innovation has been a key success factor for many companies that have consistently generated excess shareholder returns. Therefore, investing in innovation can provide opportunities for alpha returns.

How will you capitalize on future disruptive technologies?

Part 2

Robust Framework for Investing in Innovation

The challenge, for investors, is to identify investable opportunities in innovations which have the potential to change our world and how long their influence will last. Using purely quantitative methods to identify themes and companies is not an effective approach and automated screening processes do not work because of how subjective it is to categorize and define emerging innovation with exponential capabilities.

Morningstar has created a robust framework to identify innovative companies employing a fundamental and bottom-up approach. Using a systematic approach and relying on the deep understanding of each company’s fundamentals of over 100 equity analysts, Morningstar has identified 9 key themes in innovation and assessed each company’s (over 1400 companies under coverage) exposures to them.

Key Themes in Innovation

Morningstar’s Technology Steering Committee set out to identify innovations with the potential for exponential growth, keeping in mind the following guidelines:

  • Not all technology advances are easily investable
  • Not all technology advances at an exponential pace
  • Not all technology advances are created or applied by companies in the tech sector
  • Themes within innovation evolve over time

The result of this process is the following 9 key themes in innovation identified as having the most potential to bring significant economic benefits to companies that produce and use them:

9 Key Themes in Innovation

  1. Big data and analytics: Large and complex data set analysis, i.e. hyperconnectivity, the Internet of Things, machine learning, and artificial intelligence.

Leaders: Amazon, Facebook, Alphabet

  • Nanotechnology: Applications spanning medicine, computing, industrial manufacturing, and travel (ground, air, and space) via the manipulation of individual atoms and molecules.

Leaders: Intel, General Electric, Applied Materials

  • Networks and computer systems: Connecting applications and software with hardware upgrades and revolution.

Leaders: Apple, Qualcomm, Cisco Systems, Vodafone Group

  • Energy and environmental systems: The exploration of renewable energy sources and technology advancements to reduce environmental impacts and increase operating efficiency.

Leaders: Tesla Motors, Covanta Holding

  • Medicine and neuroscience: This is related to sciences such as neurochemistry and experimental psychology that deal with the structure of function of the nervous system and brain, radically changing the way we treat diseases.

Leaders: Bristol-Myers, Roche, Novartis, Merck, Johnson & Johnson

  • Robotics: Infinite potential applications spanning technology, industrial, medical, and consumer facing channels.

Leaders: Intel Corporation, Intuitive Surgical, iRobot

  • 3-D Printing: Ample potential to disrupt several industries, from industrial manufacturing and medicine to consumer products and retail.

Leader: 3D Systems

  • Bioinformatics: This is the science of collecting and analyzing complex biological data. Exponential potential to positively impact both the duration and quality of life.

Leaders: Bristol-Myers, Roche, Novartis, Illumia, AstraZeneca

  • Financial services innovations: Areas of financial innovation include nontraditional emerging funding sources, platforms, currencies, and stored and transferred value mechanisms.

Leaders: Intercontinental Exchange, PayPal, Apple

Source: Morningstar