How to spot tomorrow’s big stocks today

published 23 March 2018

888_MW_P28_Analysis — Driving force: electric cars will drive your portfolio higher

In the last 100 years, technological innovation has changed our lives radically. It has also made canny investors very rich. For example, if you had invested £1,000 into each of the "FAANG" tech stocks Facebook, Amazon, Apple, Netflix and Google (now Alphabet) at the end of January 2013, you'd have turned £5,000 into £33,300 just five years later. But how can you spot big success stories before they break? I worked for both Battelle and Xerox many years ago and met multimillionaires in the US who had made their money by taking out second mortgages to invest in Xerox shares based on the potential of the xerographic technology developed for Xerox by the Battelle laboratories. I wouldn't suggest going that far but if we look at the history of innovative firms, we can develop guidelines for spotting future innovators.

How to invest in new technology markets

There are three main ways to invest in companies that are likely to succeed with a new technology. Option one is to invest in the companies who lead the market for the current generation of products, in the hope that they can assimilate the new technology and bring superior models to market. Option two is to invest in the most promising of the up-and-coming companies that focus entirely on the new technology these lack the baggage of previous-generation products. Finally, you could buy a "picks-and-shovels" play a supplier of a key component for the new technology.

History is littered with brands that were once huge, but failed successfully to embrace new technology. Kodak, once the world's top photography group, failed to shift from film to digital and filed for bankruptcy in early 2012. Intel, the leader in processor chips for PCs and servers, failed in the smartphone market; rival ARM designed processors that used less power and were better for battery-powered mobile devices. Nokia, the leader in mobile phones, failed to keep up with smartphones, a market now dominated by Apple and Samsung.

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The second option backing the best of the new companies is often better, but requires good timing. Investors have to wait for long enough to see which company is most likely to succeed, but not so long that they miss its high-growth phase. Successful first-movers include Dyson in bagless cyclone vacuum cleaners; ARM in mobile-processor chips; and Gilead Sciences in treatments for hepatitis C.

The third option ("picks and shovels") is often safest, but the returns may well be lower than those you can make by picking a successful first-mover. Examples include ASML (Euronext: ASML), the top company in precision lithography (key in making semiconductor chips) and Abcam (LSE: ABC), which supplies antibodies to biotech researchers and companies developing new antibody drugs.

The innovations to expect in the next decade

The likely key innovations of the next decade come in four broad categories. Firstly, information and communication technologies (ICT). This includes artificial intelligence (AI), the internet of things (IoT) and cybersecurity. The latter will become ever more important substantial spending on research and development (R&D) will be needed to counter growing threats, as the spread of ICT, AI, IoT and self-driving vehicles offer hackers ever-greater opportunities for disruption. Smaller cybersecurity stocks such as Sophos (LSE: SOPH) and NCC (LSE: NCC) have been very volatile. The largest pure play, Check Point Software Technologies (Nasdaq: CHKP), has been less so. Palo Alto Networks (NYSE: PANW) is a newer, growing company that has prioritised market share, so is not yet profitable.

New materials form the second innovation category: lithium batteries for electric cars, solid-state batteries, nanomaterials and graphene (discovered at Manchester University). Applications of the latter including flexible smartphone touchscreens are now emerging. Thirdly, there's biotechnology. Examples include monoclonal antibody drugs, immunotherapy, stem-cell therapy, gene editing and gene therapy. One particularly interesting area is immuno-oncology. Big biopharma stocks such as AstraZeneca, Bristol-Myers Squibb, Merck, Novartis and Roche all have immunotherapies on the market. But smaller biotechs include Juno Therapeutics, a blood-cancer specialist that has just been bought by larger rival Celgene, and Nektar Therapeutics, (Nasdaq: NKTR), which recently partnered with Bristol-Myers Squibb. Then there are larger biotechs with strong pipelines, such as Gilead (Nasdaq: GILD). A mid-sized group with an approved drug and a pipeline focused on immunotherapies is likely to grow faster than a big pharma with many other drugs in its portfolio.

The fourth innovation "system advances"

Finally, there are system advances, which require advances from multiple fields driverless cars (novel batteries, sensors and AI); advanced implantable medical devices (new materials, devices and biotech); or robotics (new materials, AI, novel batteries). Take electric and self-driving vehicles. You might invest in a major carmaker with electric vehicles on the market (such as BMW, GM, Nissan or Toyota); or you may opt for the new entrant Tesla (Nasdaq: TSLA), which only makes electric cars and has its own battery factory. Alternatives include a later new entrant, such as Dyson (which has a £2.5bn electric car R&D programme and is likely to use a solid-state battery based on technology from its Sakti3 acquisition).

However, in this case it is probably too early to judge the most likely winner on the manufacturing side, so a "picks and shovels" play, such as Nvidia (Nasdaq: NVDA), which supplies AI chips used both in self-driving cars and many other applications, could be an interesting early investment. Another good systems example is from robotics, where Intuitive Surgical (Nasdaq: ISRG), the global leader in surgical robots with its da Vinci systems, has an excellent record of profitable R&D-driven organic growth.

Dr Tubbs owns shares in many of the firms mentioned here, including Abcam, AstraZeneca, Alphabet, Amazon, BMS, Gilead, Intuitive Surgical, Novartis and Roche.

For decades, Dr Mike Tubbs worked on the 'inside' of corporate giants such as Xerox, Battelle and Lucas. Working in the research and development departments, he learnt what became the key to his investing. Knowledge which gave him a unique perspective on the stock markets.

Dr Tubbs went on to create the R&D Scorecard which was presented annually to the Department of Trade & Industry and the European Commission. It was a guide for European businesses on how to improve prospects using correctly applied research and development.