We present here some results of a study on U.S. listed companies in the healthcare sector (Nasdaq, NYSE and Amex) based on their patent activity based on PCT (Patent Cooperation Treaty) patent applications administered by the World Intellectual Property Office (WIPO). We have shown that:
- Companies filing PCT patents fare better than the ones which don’t.
- Models relying on PCT patent applications translate into forward looking innovation and strong market outperformance versus current methods relying on granted patents (past innovation). This is evidence of the strength of patent dynamics with the identification of patent patterns/clusters and cycles of innovation.
As explained in previous SA articles (17 Healthcare Companies To Consider Based On Patent..., 40% Return In ~4 Months With Our IP Selected Health..., In Which Company Should You Invest In, Taking Into ..., In Which Field/Sub-Field Should You Invest In, Taki..., Patent Dynamics And Stock Performance):
Innovalpha has developed proprietary IP and quantitative investment models based exclusively on patents. Patent applications are processed on a weekly basis and result in a proprietary IP index for each company that files patents. Patent patterns/clusters are identified from the IP index, grading all companies that are filtered through.
Innovalpha has shown that more alpha is generated amongst innovative companies (backtesting and real track performance), as measured by weekly fluctuations in specific patent filing activity. From a weekly intellectual patent index (PI), it is possible to calculate innovation/patent scores for any company worldwide that files patents.
These IP models provide buy and sell signals for stocks essentially saying that now is the time to consider those stocks based on patent dynamics/patterns. In other words, companies that have seen quite recent notable increase in patent activity (see examples below) corresponding to identified patent patterns/clusters by the IP models provides support to integrate these stocks in your watch-list.
As mentioned in a previous SA article:
Such patent patterns reflect in principle interesting internal innovation that may lead to products on the market. At the minimum, such recent patent patterns reflect management belief that such innovation deserves consideration with consequently substantial financial and human resources allocated through increased patent-filing activity over a defined period of time (and the smaller the company is, the greater likelihood this is correct).
In summary, identification of patent patterns or profiles is an indication of growth within a company. The IP models do not assess the value of a patent per se, which is already a very difficult and likely impossible task for a patent expert, but takes into account the type of patent and fluctuations of patent activity over time (patent patterns/clusters). The SA article "Patent Dynamics And Stock Performance - Part II On IP/Patent/Innovation Indexes" provides further information, explanations and examples of the IP/patent models/Indexes.
Construction of IP models and IP/Patent Index
Currently, nearly six thousand (5796) companies are taken into account by the IP algorithms corresponding to Nasdaq, NYSE and Amex constituents.
The models/algorithms are built as follows:
i. Patent Profile: Each company's patent activity over time is unique (= history of patent activity). Algorithms have been designed to capture each company's patent profile on a weekly basis = IP [Patent] index for each company. The IP index fluctuates over time.
The IP index takes the following factors into account:
- Type of patent data - this is a quality measure as patents are not equivalent per se (different types of patents coexist, e.g. utility patents, design patents, innovation patents, patent applications, granted patents…).
- History of patent activity of a given company (distinct period of time for each company).
The IP index is therefore calculated in the same manner for all companies worldwide, whether private or public, for all sectors and regardless of the size of the company.
ii. Patent Dynamics: Among the thousands of different patent profiles (IP Index over time), specific patterns or fluctuations of patent activity over time have been detected to be correlated with market outperformance (alpha) via backtesting (patterns may be related to intense innovation, product launch, good management, etc.) = Patent Dynamics
iii. Ranking: The degree of outperformance is dependent on the type of patent pattern (e.g. a pattern A results in a better outperformance than a pattern B). This enabled the construction of a ranking system...
The IP models therefore enable the determination of buy and sell signals but also recommendations. The actual implementation of the buy/sell signal, i.e. the buy and sell recommendation (the moment shares of the company are bought/sold,) is not necessarily immediate following the buy/sell signal and may depend on the sector of activity or determined exclusively by each patent index . The buy/sell signal may be implemented after a few weeks or months. The time interval between the buy signal and its implementation (buy recommendation) may represent the average time needed for a company in a given sector to actually develop and market the products derived from in-house innovation, which will in turn materialize into equity return.
Criterion for success? Which are the factors and patterns that lead to outperformance? The main factors consist of a certain level of patent history and evidently the type of data used. Patterns that lead to outperformance include i) constant and progressive filing activity over a certain length of time and ii) increased or intensive filing activity over a shorter period of time. A lot of variations have been derived from these basics concepts. In general, a steady (even slow) increase over a certain period of time (from approximately 3 years) is in principle better than a rapid increase in a short period of time (e.g. 6 months). This makes sense for the rationale as it underlies a sustainable innovation/business.
In summary, Patent Dynamics is the design of unique models to identify specific patterns of innovation in any given Patent Profile. The use of patent data with patent dynamics represent a synergistic combination, which provides an entirely new way of identifying and selecting innovative growth-driven companies."
Evidence of alpha generation has already been shown in previous Innovalpha SA's articles/blogs. From the Patent Index, other scores can be computed like a patent value score, a patent risk score and a patent disruptive score.
As mentioned in a previous article:
the IP models contribute significantly in the selection of promising innovation-driven and patent-centric healthcare companies because:
i) companies in the healthcare sector more often rely on patent assets, i.e., secure their innovation with patents (sector with high patent activity albeit the average IP index is not the highest, see SA previous article); and
ii) patent patterns/clusters synonymous of alpha generation are consequently more often identified within this sector.
Innovalpha's (IA) expertise is therefore in the development of IP algorithms for the early detection of innovation-driven companies (and not in classical financial analysis).
We believe that the combination of Patent Dynamics with financial analyst opinions will increase the likelihood of stock outperformance.
Figure 1 shows the best companies according to their weekly overall patent score that considers patent value, risk and disruptive capacity computed from their patent index. On the podium is Edward Lifesciences Corp (EW), Novartis AG (NVS) and Merit Medical Systems Inc. (MMSI)!
These companies display a high overall patent score taking into account patent value, patent risk and patent disruptive scores. Such high scores are evidence of the intense innovation activity within these companies with identification of clear patterns/clusters. Investors shall definitively consider these companies for further analysis.
Figure 2 shows a more detailed view of the best companies displaying their patent index, grade, patent value, patent risk and patent disruptive scores. After Edward Lifesciences Corp (EW), Novartis AG (NVS) and Merit Medical Systems Inc. (MMSI), we have Amgen Inc. (AMGN), Juno Therapeutics Inc. (JUNO), DENTSPLY SIRONA Inc. (XRAY), CONMED Corporation (CNMD), Baxter International Inc. (BAX) and Eli Lilly (LLY).
Figure 2 shows that in particular EW and NVS with eventually AMGN are heavy PCT filers. It it interesting to note that EW and NVS, despite being such heavy filers, are the top companies in the healthcare sector.
Patent value score is related to the identification of the patterns/clusters which translate into alpha generation. The higher the value, the more patterns/clusters have been identified. The investor should note that it is better to select companies at the start of their innovation cycle (not indicated in the Figure) as stock market price might have already increased. Further, financial analysis is therefore warranted before including any of these companies in your portfolio. We can see that all these companies display similar patent value scores.
Patent risk score is related to patent activity. We can see that all these companies display similar patent risk scores. Advantageously, the investor can choose companies according to their patent risk score in order to adapt to the risk profile of the investor. However, as is usually the case, the investor should note that the less risk taken, the less probability that alpha will be generated, and, on the other hand, the more risk taken, the more probability that alpha will be generated (backtesting evidence).
Patent disruptive score is also related to patent activity and in particular to specific patterns of intense patent activity over a particular period of time. It can be seen in Figure 2 that among all the patent scores, the patent disruptive score is the more diverse and explains the most the difference in the company ranking. In general, it is more difficult for heavy PCT filers to display high values in such scores. Disruptors are more easily found in new emerging companies. Hence, it is interesting to note that EW, NVS and to some extent AMGN still display important disruptive capacity despite their size.
The investor should also note that the mere filing of PCT applications is an indication of success, but certainly not the best way to select companies. What is much more interesting are the specific patterns or fluctuations in the patent index detected and translated in the various patent scores.
Figure 3 shows the worst companies with a patent index (companies having no patent index are even worst). What's happening with Sangamo BioSciences, Inc. (SGMO), Globus Medical, Inc. (GMED), AbbVie Inc. (ABBV), Infinity Pharmaceuticals, Inc. (INFI), ResMed Inc. (RMD), Cleveland BioLabs, Inc. (CBLI), Clovis Oncology, Inc. (CLVS), Foundation Medicine, Inc. (FMI), Capnia, Inc. (CAPN)...?
However, Innovalpha has demonstrated that companies having a patent index fare better than companies who don’t. Hence, these companies are not the worst companies in all the companies analyzed. Investor should therefore consider avoiding these companies but not shorting them. It would be interesting for the investor to check the historical profiles of these companies which will give some perspective (see e.g. Figure 6).
Figure 4 shows the map location of the various healthcare companies.
The map is useful to immediately show if there's some diversification in the geographical location of companies selected. It is prudent for the investor not to select companies only located within one geographical region.
Figure 5 (bubble chart) shows why Novartis AG (NVS) definitively is an interesting pick taking into account its overall patent score on the Y axis and its patent risk on the X axis (the bigger the bubble the higher the PI index). It also shows that among all the companies in the healthcare sector, some are hence more riskier than others.
It can also be deduced from this Figure that the companies mentioned above (Figures 1 and 2) display good patent risk scores in comparison with others in the healthcare sector as a lot of companies in this sector have patent risk scores below 40 (which indicates that such companies have not been able yet, have difficulties to put in place innovation management/strategy that minimizes risk). Such bubble charts provide useful new perspective for the selection of companies.
Figure 6 shows the weekly patent scores over time of Amgen Inc. (AMGN). AMGN is one of the best healthcare companies in the NASDAQ according to its weekly patent scores.
Figure 6 shows stable scores until late 2017 followed with an important increase of the scores until May 2019 and a decrease thereafter. This chart provides a good indication of the innovation capacity of this company since late 2017. The investor should definitively select this company for further analysis.
As shown in Figure 7 which displays an interesting correlation of EW patent scores with its stock price over time, the investor should also check the historical patent profile of companies in order to immediately identify in a convenient way any modifications in their patent scores over time.
Figure 7 shows that the investor should have considered EW already at the least in 2015. Such charts provide evidence that an increase in the overall patent score can translate into an increase in the stock price (and in some instances that a decrease in the overall patent score can translate in to a decrease in the stock price). After all, innovation represents one of the core values of a company, with strong R&D/innovation and good innovation strategy/management translating into the filing of patent applications and hopefully in the launch of new products on the market. Figure 7 thus indicates that the investor should have selected EW already some time ago, and that its actual scores still warrant further analysis for portfolio incorporation.
In this study on healthcare companies filing PCT applications, it is shown once again the strength of the novel approach taken by Innovalpha relying on patent dynamics and cycles of innovation, in contrast to other methods that usually automatically provide a score to an individual patent, which is something already difficult to do for an expert. Obviously, the two approaches can be combined (patent applications and granted patents), but Innovalpha further demonstrates here that methods based on patent applications provide strong outperformance and are therefore reliable in the detection and selection of companies.
Based on their patent scores and historical profiles, investors should:
- consider the following companies for further analysis, in their portfolio (long/hold): EW, NVS, MMSI, AMGN, JUNO, XRAY, CNMD, BAX, LLY, and
- avoid the following companies, but not short them: SGMO, GMED, ABBV, INFI, RMD, CBLI, CLVS, FMI, CAPN.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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