Companies that invent something completely new to the world earn much higher returns than those that just invent something new for themselves.
The stock market provides a specific and measurable premium to firms that push the global technological frontier. Most businesses focus on firm-specific exploration to catch up with their competitors. While this is helpful for the company, it does not provide the same risk-adjusted returns as market-wide novel innovation. Investors can use the semantic distance of a patent from existing technology to predict future performance. This distinction proves that being a true pioneer is more profitable than just being a fast follower.
Technological Innovation and the Cross Section of Returns
SSRN · 6619918
We introduce Technological Innovation Novelty (TIN), a text-based measure quantifying each patent's semantic distance from the existing technological frontier. Aggregating to the firm level (FTIN), we find that firms producing market-wide novel innovation earn significantly higher risk-adjusted returns. A value-weighted long-short portfolio generates risk-adjusted returns of up to 53 basis points per month, robust across alternative factor models, the exclusion of microcaps and other innovation