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Investing in Innovation

Investing in innovation sounds like a good idea but the concept can be problematic. A recent news article from Connecticut comes to mind as well as President Nixon’s “War on Cancer” nearly 40 years ago. Connecticut has passed a number of laws offering incentives to bioscience companies and to municipalities with a major research university with a bioscience program. These laws are intended to attract investment capital, provide jobs, and lead to taxes being paid into the state coffers. Nixon’s war on cancer came on the heels of a dramatic cutback in federal funds for basic research occasioned by the mounting cost of pursuing a war in Asia and increasing social programs. The problem with investing in innovation, especially basic research, is that even though results can occasionally be spectacular it takes years to see a payoff for the investor. Also, basic research, seeming unrelated to anything “important” is often the root of scientific innovation. An example is the discovery of penicillin because a petri dish was dirty.
It is difficult to do fundamental analysis on a company with no products, no sales, and working in a technology understood well by only half a dozen people in the country.

To the extent that similar laws and incentives provide general incentives to upgrade research efforts, reduce costs, and give incentives for hiring more staff, and start new programs the laws may improve cash flow in some small research companies. However, this is not sufficient incentive for an outside investor to invest for short term gain. The long term gains from investing in innovation come from picking companies with talent in basic research and, more importantly, bringing research ideas and basic research findings to market in a sellable form, the “killer application.” A company such as Apple under Steve Jobs is a shining example of the ability to take current technology and convert it into popular products. Companies such as IBM and the old AT&T are examples of companies that provided the world with some of the most innovative, Nobel Prize winning research ever, but were not able to promptly turn that research into sellable products. Picking new winners when investing in innovation should probably lead investors to the Apples of the world as opposed to the old AT&T’s.

Much of investing in innovation requires either technical expertise or excellent advice. When investing in innovation many investors try to stick with companies with a long history of bringing new, interesting, and profitable products to market. Unlike startup biotech companies, companies like Hewlett Packard and Apple do not find their stock going up a hundred fold. However, these companies bring in profits, pay dividends, and see their stock go up year after year. Old stalwarts like Proctor and Gamble routinely bring popular and profitable products to market. In looking for predictable results investing in innovation is not much different than investing in beer or investing in oil. Startups and occasional home runs are nice but predictable results are better. Innovation does not just come with startup companies and innovation with startups often takes a number of years to show profits.

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