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Investing in companies with innovation in their DNA

Innovation is the intelligent application of ideas and is found in most industries. We believe good companies with a culture of innovation can develop competitive strengths that can improve their return on capital.

Why innovative companies can outperform

There are many forms of innovation, enabling companies to create value in different business areas:


1) Scientific and technological advances

  • Highly innovative products create new markets and enjoy rapid growth in demand

2) Improved products and services

  • Innovations in existing products can grow sales and build customer loyalty and market share

3) Alternative business models

  • Smarter management and improved processes mean shorter time to market for new products and shorter time to break even
  • More efficient production of existing products can cut costs, improving profitability or boosting sales by cutting prices

According to leading US consultancy Arthur D Little, top quartile innovation performers achieve on average:


1) 13% more profit from new products

2) Twice the proportion of sales for new products

3) 30% shorter time-to-break-even


Innovative companies that enjoy these improvements in revenue or profits and maintain good capital discipline will deliver what we believe are the key factors behind superior shareholder returns:


  • Higher than average return on investment
  • Persistent growth over a business cycle

Importantly, these advantages don’t just occur in early stage companies with disruptive products. Mature companies can build competitive strengths that will continue to drive profitable growth. We believe innovative companies can be split into three classes:


1) Early stage disruptive companies

2) More established companies in rapid growth stages

3) Established companies with a culture of innovation and improvement in their product, processes, or business model


Identifying innovative companies

To identify innovative companies at these different stages in their lifecycle, we apply both qualitative and quantitative screens.


1) Qualitative search for smaller, early stage more disruptive companies

We analyse journals, magazines and articles in order to identify small up-and-coming, innovative companies with potential for rapid growth and high return on capital.


2) Quantitative search for more mature companies using innovation to drive profitable growth

To identify companies that adapt to changing circumstances and create value regardless of the economic environment or competition, we screen for companies which have achieved consistently high return on capital over an entire business cycle.


Investing in innovative companies at the right price

Simply being identified as an innovative company is not in itself sufficient grounds for investment. We screen companies on the basis of quality, value, sentiment and momentum to identify the best candidates for thorough due diligence.


We seek to understand how a company has evolved over the previous 15 years (if possible). Covering factors including: growth, margins, uses of cash amongst capital expenditure, acquisitions, share buybacks, repayment of debt, balance sheet evolution, drivers of return on capital, key geographic regions, valuations relative to peers and the company’s own history, earnings sentiment and dividend cover. We also investigate more subjective factors surrounding industry trends and company specific issues.


Overall, we believe this approach can offer investors exposure to sensibly valued companies with competitive strengths built on their culture of innovation, enabling them to deliver profitable growth and strong shareholder returns into the future.

Guinness Asset Management, November 2014

Important notes

Please note that these are the views of Guinness Asset Management and should not be interpreted as the views of RL360°.

Author

Guinness Asset Management


November 2014

Please note that these are the views of Guinness Asset Management and should not be interpreted as the views of RL360°.

360° fund links

A range of Guinness funds can be accessed through our guided architecture products Oracle, Paragon and Quantum, and also through our PIMS portfolio bond.