The Only “Patented” Way to Profit from Tech Stocks
Dear Wall Street Daily Reader,
If I’ve told you once, I’ve told you a thousand times: patents matter!
Like a good parent, though, I’m going to keep reminding you why they matter.
In fact, a few weeks ago, I forced you to endure one of these patent lectures. But I left you hanging.
I gave you proof that patents are a valuable leading indicator (see here) for predicting tech trends. But I didn’t get a chance to explain how you can determine which patents are actually valuable.
After all, anyone can file for a patent. But not all of them are granted. And most of them that are granted aren’t worth the paper they used to be printed on.
So here’s how you can objectively assess the value of any company’s patent portfolio…
Four Key Patent Metrics to Track
As you know, I’ve made unearthing the market’s most significant and fastest-growing patent holders the cornerstone of my strategy for finding investments in the technology sector.
Why? Because patents produce profits. And because share prices ultimately follow profits.
So if we identify key patent holders and patent filing trends early, as the market eventually realizes the value of each company’s intellectual property (IP), we can share in those profits.
Now, Wall Streeters and accountants consider patents intangible assets, which are by definition incapable of being quantified. But that’s hogwash!
Although this list isn’t exhaustive, here are four key metrics I take into consideration to determine the value of any company’s patents:
- Patent portfolio size: In today’s environment of exploding innovation, a single patent is seldom enough. There are too many smart people in the world that can easily find another way to create the same thing. That’s why (portfolio) size matters. A truly innovative company will find ways to file a family of patents around its core innovation. Even better, the best companies reverse engineer their innovations and file patents for those discoveries, too. In other words, they build a defensive moat around their core IP by beating competitors to the punch by preemptively patenting alternative methods. As a general rule of thumb, I focus on companies with at least 50 patents around their core technology, and a commitment to continue growing that number. Speaking of which…
- Patent portfolio growth: To ensure a company is committed to innovation and protecting the value of its IP, I measure the year-over-year compound annual growth rate of the number of patent applications filed over the last three years. Since it’s based on publication date, not filing date, it includes an 18-month lag. However, this metric can still yield crucial insights into the nature and trajectory of a company’s IP development pipeline and its competitive relevance.
- Patent filing conversion rate: Simply filing a bunch of junk patents that never get granted is nothing but “innovative” window dressing. For a patent to be valuable, it actually needs to be granted. That’s why I also take into account a company’s conversion ratio of patent filings to grants. The best companies in the world boast conversion ratios of 60% or more. I’m talking about the likes of Amazon.com (AMZN) and Apple Inc. (AAPL). I want to see a conversion rate of 50% or higher, otherwise the company clearly doesn’t understand what is patentable, and spends too much time (and shareholder money) on worthless IP activity.
- Third-party citations: If a patent is extremely valuable or foundational, other patent applications are going to cite it over time. Just like how academic papers cite key research from outside sources. By looking for patents with a significant number of external citations, we can determine the quality of a company’s IP portfolio. After all, why else would competitors be citing another patent if it wasn’t valuable? This isn’t a straight evaluation of the absolute number of citations. We also have to take into account each patent’s age, the marginal value of each citation, and the total size of the company’s portfolio.
Bottom line: We can’t afford to ignore intellectual property when looking for compelling new tech trends and investments.
Not only is IP of fundamental importance to economic growth, it’s also a key driver of stock market returns.
And now that you’re on board with my strategy to capitalize on the increasing relevance and value of patents in the market, rest assured that I’ll share the most compelling patent trends and bets with you — right here in this column!
Ahead of the tape,
Editor and Founder, Trend Trader Daily