Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Michael Sayers, director of Research at Fidelity International discusses the investment potential of disruptive innovation.
In an environment where growth is increasingly scarce, companies or sectors that are genuinely innovative attract a premium. Few sectors appear immune to the effects of new technologies, inventions, discoveries and business models and the disruptive impact these can have on pricing power and market share.
The findings of Fidelity International’s 2016 Global Analyst Survey suggest that this will be one of the key trends that looks set to define the year. Innovation is spurring growth particularly in IT and healthcare, but elsewhere too. Innovation can also lead to disruption, so not everyone is a winner.
This does mean careful analysis is needed, as the fortunes of those who can capture innovation will contrast starkly with those left behind. It also creates many exciting opportunities for investors who can identify the winners of such upheaval at an early stage.
The Beneficiaries of Innovation
The sector that scores highest in our survey in terms of the direct impact from disruptive technologies is IT. New technologies are disrupting the landscape faster than ever, reshaping revenue pools across a number of industries and creating a host of opportunities. This is not only for those developing such technologies, but also for those who supply required infrastructure around them.
The surge in digital consumption, for example, requires the development of appropriate digital storage and on demand data access, while the shift to cloud computing boosts the demand for enhanced internet security services. Stocks like Microsoft (MSFT) and SAP (SAP) could be among the main beneficiaries of the shift to the cloud. There are a number of emerging technologies that could soon hit the mainstream, creating further opportunities, including virtual reality, enterprise 3D printing and cryptocurrency exchanges.
The sector benefits from rising IT spending which our analysts see increasing in all sectors except energy, materials and utilities. Most of this spending is on software but increasingly also on mobile and cloud services.
How Healthcare is Changing
Healthcare is also a beneficiary of innovation, although this is captured within research and development (R&D) more than new technologies. Much of the ongoing innovation is driven by global aging – which our analysts note is as a major positive factor for healthcare in the next 10 years – and the search for treatments for chronic diseases. Genome sequencing and more focused R&D – aided by the collapse in genome sequencing costs – is expected to result in high levels of drug approvals by the US Food and Drug Administration.
The healthcare sector’s innovation cycle typically lasts 10 years; it is currently three years in with a very healthy pipeline of new discoveries and treatments. New treatments for hepatitis, which was previously not curable but can now be treated effectively, and multiple sclerosis constituted earlier successes in the current wave.
Next is the scientific effort against cancer – the development of immunotherapy, for example – which has a slightly longer development cycle expected to last for 10-15 years, with Roche (RO) perhaps the leader in the oncology space. All of these are fuelled by innovation and continue to support longer-term growth in healthcare.
This helps to explain why our survey shows that management confidence at healthcare companies is expected to remain robust over 2016, with a clear majority of analysts reporting confidence as either rising or the same as last year.
The Companies Losing Out to Innovation
However, innovation also leads to disruption, so not everyone is a winner. Consumer discretionary companies are particularly exposed to this with a majority of analysts citing a moderate to high impact from disruptive technologies.
Amazon’s (AMZN) challenge to Walmart’s market positioning shows how fast a company’s competitive edge can be eroded when it finds itself on the wrong side of innovation-driven disruption. Amazon’s internet-based ordering and delivery system proved so much more efficient that it managed to gain significant market share from many incumbent store-based retailers in just a few years.
Media firms are also particularly exposed to innovation and the disruption it triggers, as witnessed by the success of Netflix, whose novel and popular internet-based service has flourished at the expense of established cable and broadcasting companies.
With innovation being one of the key trends spurring growth in 2016, careful analysis will be required. The fortunes of those who can capture innovation will contrast starkly with those left behind, but this also creates many exciting opportunities for investors who can identify the winners of such upheaval at an early stage.
Disclaimer
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