Monday, August 31, 2009

Searching for Innovations

My muse was resting over the weekend, thus this blog was a bit delayed.

In last week’s blog I was describing the search for meaningful innovation as one of the approaches to find true “growth stocks.” Luckily for me and my investors, I have the ability to frequently discuss scientific breakthroughs with Dr. Philip Neches and other fellow members of the Caltech Board of Trustees. Application of science is another way to find innovations that will change the commercial balance of power. As with many of my ideas, they are not new and often they have been used before in mutual funds around the world. Years ago there was fund which, in theory, invested exclusively in electricity. Initially they invested in electrical power producers and some utilities. As time went on, many of the electrical power producers merged, and utilities became unattractive investments. The portfolio managers broadened the list of acceptable stocks, eventually reaching the conclusion that any company that used electricity was a candidate. While the managers’ conclusion may have been a too wide an application, the principle is the father of my thought process today.

Before I discuss certain applications of technology to everyday experience, I believe it is important to share my views as to why innovation is so important today. In classical economics, one of the rationales for the cyclical nature of economies’ progress is that the declines were to reduce or eliminate the excesses. Though most attention is being paid to leverage as the cause for the current decline, I suggest there were a number of other excesses. Under the cover of rising revenues, numerous companies over-hired. This was understandable, as hiring is always a gamble as to whether the candidate really fits the critical need of the organization. In addition, employee welfare services expanded. In the subsequent decline, a good number of these jobs were eliminated, yet many of the chastened employers now recognize that while they eliminated the jobs, some of the needs remain. This is exactly the type of environment where innovation can, and often needs, to flourish.

Even during the current period of low interest rates (and therefore low float value), extensive work is being conducted on payment systems. This work is impacting securities markets, commercial markets, international markets and markets that individuals use. The drive for all of these efforts is not primarily to capture float, but to improve the collection of credit. (I am told by one of my sons that the difference between a good small bank and one that gets in trouble is the speed its collection system can identify problems.) Since much of the work done in the payment systems world is machine rather human-based, productivity goes up.

One of the more intriguing insights to the payment system world is being practiced by a very large retailer who was denied a banking license, yet is providing a bill payment service for individuals. Many, but not all of the customers for this service are already customers of the store. The essence of a bill paying system is the optimum timing of paying bills. This concept is very sophisticated for people of all wealth strata, but particularly for those who shop in low-end stores. We have known throughout history that some people of limited means are very good money managers. (Hopefully, they will be the next generations’ bankers.) The intriguing question is: Can we get a larger portion of the people with limited resources to become better money managers? If bill paying services open the way, the impact on this country’s long term financial status will be incredibly improved.

Other examples of innovation are the uses of hand-held devices. On a recent trip to visit the wise people in Boston, the woman boarding the plane ahead of me displayed her Blackberry which had her boarding pass on its screen. The attendant used her optical card reader wand and the woman was processed through the gate faster than those of us with computer printed paper. If more passengers could be processed this way, labor would be saved and boarding time reduced. Imagine the benefit when a flight is cancelled and rapid rebooking becomes necessary.

These are just a few examples of innovative applications. We need to find others that can impact publicly traded stocks and fund portfolios. We will probably find these more in small caps and micro caps than in large caps.

Any thoughts?

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