Innovation, the common factor behind the greatest stock market successes

Analysis

By Arnaud Brossard, analyst-manager at Lazard Frères Gestion

Innovative companies stand out on the stock market every year. By accelerating certain social and technical transformations, 2020 with the Covid-19 pandemic was no exception. But how to identify innovative companies whose shares have not yet exhausted their upside potential?

When we think of innovation we often think of technology. Innovation is not just limited to this sector however. Recent history has provided many examples. Among the major stock market successes of recent decades are stories such as Essilor in eyewear, L’Oréal in cosmetics, McDonald’s in catering, Michelin in tyres, Toyota in automotive, and Zara in clothing.

All these companies share the fact that their success has been driven by innovation with progressive lenses at Essilor, ethnic marketing at L’Oréal, hamburger automation at McDonald’s, manufacturing procedures at Michelin, the just-in-time at Toyota and express fashion at Zara, to mention just one element of their innovation. This shows that innovation is varied, not only in terms of the sectors where it appears but also the forms it can take. It is above all a powerful creator of value. Indeed, innovation is what enables a company to stand out from the crowd, gain an edge or create a market in which it can maintain a lasting lead.

Efforts and adjustments

However, not all innovation is synonymous with success. There are also many examples of failed innovations that have found no audience. These include the “Google+” social network and Microsoft’s Windows 8 operating system. Similarly, the Airbus A380 did not enjoy the success hoped for. However, these flops have been more than made up for by other innovative ideas from the same companies. Innovating is therefore a process of efforts, failures and adjustments. Nespresso is a perfect example: based on a technical idea to enhance the taste of coffee, its creators took years to develop a suitable machine, and then a further decade to identify the right way of marketing the machine and its capsules.

Simply having a good idea is not enough. The key factor is to put an idea into practice over the long-run. Amazon is also a good illustration. Admittedly, the idea of using the internet to sell books came early in 1994, but others had also thought of it. Amazon initially targeted growth rather than earnings, and even flirted with bankruptcy in the early 2000s. The company was aiming for unique logistical efficiency, and stepped up its sales with the invention of the Kindle, before extending its offer beyond books and exploiting its IT infrastructure to create the first cloud offer. It was through the countless decisions and actions that went hand-in-hand with these ideas that rising customer interest, sales and profitability were generated.

Knowing how to identify the successes of tomorrow

One question comes to mind however: how to invest in innovative companies at the right time, before their stockmarket take-off? One thing is sure: the best candidates are initially little well known and difficult to spot. The search for innovation therefore needs to be placed at the heart of the approach, including meetings with company directors to study their projects carefully and find future winners at attractive prices.

This work requires much open-mindedness. Studying innovation means dealing with new concepts that are sometimes strange and difficult to assess. Innovation above all arises where we do not expect it to be. We need to recognise that the unexpected choices of some companies could be major innovations for their market. This method is clearly not risk-free and promising projects can sometimes prove disappointing. However, this strategy is also the means of picking companies that go on to boast outstanding performances. Michelin, Essilor and Amazon have risen by 7, 14 and even 37%[1] a year since their flotations, clearly outperforming their benchmark index.

It is therefore in the interest of investors to consider this type of strategy over time. Over the long-term, innovation has proved to be the most durable source of value creation.

* * *

Risks specific to equities markets: risk of capital loss, equity risk, risks related to the capitalisation, emerging markets risks, liquidity risk. There is also a risk associated with discretionary management in connection with fund management.

Article written on 25 March 2021. The information provided is not intended to constitute investment advice and is intended for information purposes only. The data used in this document is used in good faith, but no guarantee can be given as to its accuracy. All data contained in this document, unless otherwise indicated, comes from Lazard. Past performance is not a reliable indicator of future performance.

[1] Source: Bloomberg. Past performance is not necessarily an indicator of future performance.

Sources: Bloomberg and Lazard Frères Gestion


-- PDF --