Unfortunately we’re attracted to innovation like a moth to a flame. You can just see the bucks going up in smoke.
Innovation has two very nasty effects on investors. The first one is that it gets everyone excited, often over-excited. It’s possible to trace most of the great booms in stockmarket history to the over-enthusiasm of investors for some new technical trend.
In the mid-1800s the great railroad boom made mass travel for the masses a reality in England and opened up the great American wilderness. Railroad stocks boomed, but most investors lost money when not enough people were able or willing to pay for the use of the new networks. Yet the railroad revolutionised many other industries, allowing producers to be sited away from consumers, and creating previously unheard of economies of scale.
In the 1920s the twin inventions of the automobile and widely available electricity led to a boom in associated corporations. A cycle played out in which common enthusiasm for these trends led to overinvestment, a stockmarket boom and an inevitable crash. The Wall Street Crash.
And, of course, in the 1990s the internet boom caused a similar cycle. Yet we can see today that there were many opportunities – they just weren’t where people thought they were. The internet is even now revolutionising publishing and IT industries of all kinds: digital publishing is destroying the old distribution channels and widespread high-speed broadband access is making outsourced cloud computing facilities a viable way for many new business to start trading.
This is the second way in which innovation is a bane to the investor: it destroys existing, often long-established, business models. This process of creative-destructionism usually, eventually, leads to simpler, better ways of organising corporations and lives. But in the meantime all of those careful investment plans, built on careful historical analysis of sales and earnings can go hang.
So, yes, I love innovation personally. But as an investor I’d rather find something which is more likely to stand the test of time. Powerful brands and physical goods are harder to displace. Although even there you can never tell … (see: 3D Printing is Not Exogenous).
Booms based on innovation never end happily for over-excited investors, but they can end equally badly for cautious ones. Reviewing investment assumptions built on historical data is a constant necessity for innovation-shy investors.
Innovation is a regular theme, particularly developments that may hold it back: from issues about patent trolling in Pulling Up The Intellectual Property Ladder to anti-trust problems in Behavioral Anti-Trust: From Microsoft to Apple. We looked at the modern miracle of innovation in An Age of Miracles and Wonders and the dangers and opportunities in the current environment in Moats, Unbundled, Book Value and Disruption by Digital Wallet: The Sailing-Ship Effect Rewritten. Recent financial innovation is covered in Nowcasting With Google, Noise, Sentiment and StockTwits, The Wisdom of Internet Crowds, The End of Finance, As We Know It and Can Software Beat Penny-Flippers? The basic idea of creative-destructionism was addressed in Time for Shiva and Schumpeter and the history of the railway boom was touched on in From the Railroad to the Internet ... and Back Again and, of course, Sherlock Holmes' infamous Case of the Delusional Investor.
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