Short These Three Large Caps That Lack Innovation

This article was written with Oliver Pursche, the Co-Portfolio Manager of GMG Defense Beta Fund. It was part of a series of articles developed under an agreement with to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site, is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.

In January I wrote about the role of innovation in stock selection. Basically, I posited that companies, particularly non tech companies, that innovate are the ones that create value for investors.

At the time, I was buying the following stocks that were also members of the Thomson Reuters Top 100 Global Innovators for 2011: Raytheon (RTN), Chevron (CVX), Boeing (BA), Exxon Mobil (XOM), E.I. du Pont, (DD), Procter & Gamble (PG) and Unilever (UL).

Not only have investors in these stocks earned some pretty good gains, but they’ve been paid a healthy cash dividend, twice, with more to come. Even with Boeing, where the dividend yield just about matches the contraction in the shares, you can make the case that investors are being paid to wait.

Since that time, I think the world has gotten to be a tougher place, economically speaking. World GDP growth is near zero. Corporate earnings are tough to come by. In fact, in a zero growth environment, innovation is the only realistic path to sustained earnings growth.

Innovation is not a squishy term, and I suspect it cannot be delivered by schmaltzy posters in the corridors of corporate headquarters with photos of soaring eagles, and crashing waves (The End Is The Adjacent Angle To The Beginning anyone?).

Reuters measured it as follows: 1) The incidence of success in securing patents; 2) The overall volume of patents; 3) The degree of influence (i.e. how often a company’s patents are cited in other companies inventions) and 4) The number of “quadrilateral patents” (i.e., patents for the same invention at the Chinese Patent Office, the European Patent Office, the Japanese Patent Office and the United States Patent Office).

On a broad-brush level, this brand of innovation has served investors well as, according to Thomson Reuters, the leading global innovators outperformed the S&P 500 in market cap gains by a lot: 12.9 percent v. 7.2 percent, respectively.

If you take this kind of argument to heart you might get some ideas on stocks to short as well. The following three companies, nowhere to be found on the Thomson Reuters list of innovators could, I suspect, meet the fate of Kodak, Woolworth and Atari.

General Motors (GM): The U.S. government still owns about 26% of the company, roughly 500 million shares, without this taxpayer support, the company almost certainly would already be bankrupt.

Lowe’s Companies (LOW): Recent earnings results says it all. Unable to compete with Home Depot, the company is trying to “shrink” itself to success–a strategy that has almost never worked.

Bank of America (BAC): I know it’s tough to imagine, but with Merrill Lynch rapidly turning into an archaic broker and the “bank” consistently being last to market with innovative products like electronic deposit by smart phone, this once venerable company could get broken up as soon as next year.

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