Innovation Nation: Finding Stock Market Winners

The authors explain that it's essential to beat the competition while a new industry is still evolving. Successful companies ride the S curve to success via innovation and then jump to the next curve with new innovation – repeatedly. After initially succeeding through innovation, most companies plateau because they don't reinvent their mentalities, cultures or products. The book explores how industry leaders were caught off guard as Apple reinvented the recorded music business and then the mobile device business.

All-Star investor and founder of Investor's Business Daily William J. O'Neil studied the best-performing stocks for the last 100 years and found seven common characteristics. These traits are factors in O'Neil's highly regarded CAN SLIM Investing System. The "N" in CAN SLIM® stands for "new," assigned high-performing companies that have advanced through a new product or service that has changed our lives or the way we do business.

How can investors identify the next big thing and the companies that will exploit it most profitably?

Here are some things to look for:

• Extremely rapid growth. When a company's growth is meteoric, it's usually because of innovation. Increasing growth in annual and quarterly earnings of about 25 percent or more is usually a good indicator of fruitful innovation when combined with accelerating sales. Examples are cloud computing companies VMware and Rackspace. Of course, some would say that this rapid growth is pricing up such stocks to the point where they're not a great investment. Yet companies that are truly innovative can jump onto the next S-curve, spurring acceleration of earnings and an upward revision in estimates by Wall Street analysts. Will a rumored Apple television device be the company's next S-curve?

• A strong commitment to research and development (R&D). Merely throwing money at R&D doesn't guarantee that companies will make money from what they develop. But without a commitment to R&D spending, no successful innovation will occur. Look for management who have a zeal for innovation, as opposed to a caretaker mentality. For example, in an interview in Bloomberg Businessweek Amazon CEO Jeff Bezos stated that there is no bad time to innovate: "You should be doing it when times are good and when times are tough."

• The presences of numerous new players in a given industry. New entrants are attracted by areas of opportunity, which hold potential for strong returns. Not every new entrant will succeed, but the more entrants there are, the greater likelihood of successful new business models that generate much high returns for shareholders.

By assessing these factors, investors can begin to get a better idea of who is innovating and who isn't. Of course, all innovations don't result in dramatic growth. However, a discernible lack of innovation is usually a clear sign of a company that won't ultimately become a high performer, consistently surpassing its peers in revenue growth, profitability and total return to shareholders.

Craig J. Coletta has 20 years of experience in the financial industry. He is president of C.J. Coletta & Co., a Registered Investment Advisor firm, and president of Coletta Investment Research Inc. Coletta is a Chartered Financial Analyst charterholder, a Chartered Market Technician and a Certified Hedge Fund Professional. He holds a B.S. in accounting and business administration from Rider University, and is a member of the American Institute of Certified Public Accountants.

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