MARKET MINUTE FROM BLACKROCK FUNDAMENTAL EQUITIES

Investment return, courtesy of innovation

May 17, 2021
  • BlackRock Fundamental Equities

Change happens faster than ever these days, and that has made innovation an important area of analysis for active stock pickers looking to uncover companies with outsized growth potential.

The pace of change has accelerated dramatically in recent decades – and was amplified as the COVID-19 crisis pushed many budding trends forward by years. This innovation is increasingly being rewarded, as adoption rates for promising products and services have also accelerated across time. The illustration below shows that it took 46 years for a quarter of the American population to access electricity. Fast forward a century and it took only 16 years for PCs and seven years for the Internet to gain the same level of adoption.

Change happens fast
Time taken for new technology to reach 25% of Americans

Change happens fast

Source: BlackRock, with data from Pew Research, Chart of the Week as of March 2014: The ever-accelerating rate of technology adoption; and Yahoo Finance as of July 2019 for the number of active users on Facebook over the years.

Will Broadbent of BlackRock Fundamental Equities’ U.S. Growth team believes investors are also poised to be rewarded for their exposure to innovative business models. He sums up the opportunity in this BlackRock Bottom Line video, and addresses four key questions here: 

Is innovation a tech-specific investment proposition?

Absolutely not. Innovation is happening irrespective of industry sector and company size, and we see it as a key driver of investor returns over the next 10 years.

We used to think of innovation specifically in consumer electronics, or in certain technology verticals. Now we see it across transportation, consumer discretionary, industrials, energy and healthcare. Just consider the pace at which the COVID-19 vaccine was developed. A scientific feat that once required several years to achieve was accomplished in less than one. In many ways, innovation has become more inclusive and, in turn, is widening the lens through which we can examine corporate change and investment potential.

How do you separate a flash in the pan from an innovation with lasting utility?

This is why it’s so exciting to work in active management. Our days are spent separating winners from losers and thinking about which type of competitive differentiation is defensible and which is not.

We have a robust process for evaluating and assessing innovators that helps us to very effectively separate durable innovation from fleeting innovation. Durable innovation tends to be gradual and often represents an improvement on a legacy process or product. Fleeting innovation tends to be a new discovery with unproven commercialization and, many times, results in binary investment outcomes.

We see durable innovation as a more investable theme in a portfolio of publicly traded equities, as it expands upon an existing product, service or business model. The change is incremental, not obvious and very often leverages technology to extract accelerating unit economics and drive improving growth in a business. We believe durable innovation is a better way to drive long-term returns.

Are large companies better equipped to execute on innovative ideas?

That is less true today than in the past. Large companies used to be able to exercise significant market power over poorly capitalized businesses, many of which were sub-scale. This still happens today, but not to the same extent.

Many of the world’s largest companies are making enterprise tools available to smaller companies, allowing them to scale quickly and at a fraction of the cost versus prior generations. Consider the world’s largest online retailer which, despite its dominance, has empowered a new cohort of companies that are leveraging its tools and the growing online consumer marketplace to build their own businesses cheaper and faster. We see tremendous opportunity in the small- and mid-cap space, where many great businesses are overlooked and underowned.

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Innovation is happening irrespective of industry sector and company size, and we see it as a key driver of investor returns over the next 10 years.

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Has the pandemic pulled demand for some of these innovative ideas forward, stealing from the future?

That may be the case in pockets, which is another reason active stock selection is critical. But the pandemic put a spotlight on trends that were already solidly in place  things like telemedicine, web conferencing, ecommerce, home fitness, mobile workforce and remote learning  and arguably cemented these behaviors and practices as norms not exceptions.

Like investment returns, we think innovation has a compounding effect. It used to take years or decades for innovations in one sector to work their way to others. Now, it happens practically overnight. Small innovations in one business can reshape seemingly unrelated industries. These incremental changes can drive further innovation that benefits both companies and their shareholders over the long term.

For more insights on innovation and growth investing, see A stock picker’s guide to growth.