Originally posted on The Horizons Tracker.
Technological advances are often viewed as isolated events that only impact the company that made the breakthrough. New research1 from Stanford highlights how individual breakthroughs can have a broad impact. The researchers believe that the smartest investors can identify the connections technology can create, and gain the march on the market as a result.
“Technological capability drives growth, but these capabilities don’t occur in isolation,” they explain. “There are overlapping technologies, subject to common shocks, and there are knowledge spillovers. Our central hypothesis is that investors don’t quite understand these sneakier connections between companies.”
At the heart of the connections is underlying expertise that is often reflected in the kind of patents companies receive. For instance, while a biotech company may be fundamentally different to one making equipment for analyzing gene sequences, they may both have patents in molecular biology and therefore be more interlinked that it appears on the surface.
Stealing a march
By spotting this connection, the researchers believe that investors can better appreciate that important breakthroughs for one company could also be invaluable for others too.
“Our hypothesis was that when good stuff happens to your technology peers, then it is likely to happen to your company too,” the researchers explain. “If bad stuff happens to your tech peers, then that may be down the road for you as well.”
When they analyzed share data and information on technological closeness, from over 700 different kinds of technology, this did indeed appear to be the case. The hypothesis was further examined via thousands of computer simulations, with the simulations aiming to test whether buying or selling shares based upon these hunches would indeed have resulted in the investor outperforming the market.
Lo and behold, the strategy did appear to have merit, with the approach able to deliver returns that were around 1.17% higher than investments made in similar companies with comparable risk factors.
The approach seemed to work best at predicting stock movements over the coming six months, with its predictive power fading over longer timeframes. It’s also a particularly effective approach at spotting hidden gems that don’t attract a great deal of attention from analysts and professional investors. This is a domain in which informational asynchronicity can really come to the fore.
Aside from the investing potential however, the authors believe their findings also remind us that technology companies can have a lot more that binds them than originally appears at first glance.
“Firms that compete in different markets and industries, firms that you wouldn’t think of in the same breath, are actually quite close in terms of their technological expertise,” they conclude. “Their fortunes are going to move together.”
Article source: The Hidden Linkages That Underpin Technological Success.
- Lee, C. M., Sun, S. T., Wang, R., & Zhang, R. (2019). Technological links and predictable returns. Journal of Financial Economics, 132(3), 76-96. ↩