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Who Walks the Walk?

For instance, some cutting-edge researchers believe this approach can be used to pinpoint companies that will outperform their competitors. Francis Narin, president of CHI Research of Haddon Heights, N.J., has emerged as a pioneer in assessing firms’ technological strength. Narin believes that, in looking at the patents a high-tech firm generates, three variables are crucial: “citation intensity,” “science link” and “technology cycle time.”

Citation intensity gives an indication of how influential a particular patent is based on how often it’s cited in other patents. Science link represents the number of scientific papers cited in each patent, and technology cycle time is the median age of the patents cited in all of a company’s recent patents; these last two measures form a way of quantifying the widely held assumption that the most innovative patents are closest to the forefront of science and technology.

Narin has long combined these three factors to rank firms in key high-tech industries. Now, however, he’s going beyond just measuring to try to prove that high marks on these scales pay off financially. In a study published this spring in Financial Analysts Journal, he teamed with New York University finance expert Baruch Lev and doctoral student Zhen Deng to find out whether technological strength itself is an indicator of a firm’s future financial performance.

The trio’s hypothesis was that a company whose portfolio contains highly cited, science-rich patents is likely generating innovative technology, providing a marketplace advantage that will show up in future stock prices and market-to-book ratios-the stock price in relation to the value of a firm’s hardcore financial assets. All told, they studied 388 companies in four high-tech sectors: chemical, drugs, electronics and “others.”

Narin, Lev and Deng compared company results against industry averages, then gauged each firm’s market performance over the next year or longer. In line with their hypothesis, the market-to-book ratios of companies with high citation intensity and high science linkage outdid those of companies ranked low in both categories by 25 percent. These “high-high” companies also tended to do better in the stock market, though results were more mixed.

Since just about every company these days claims to be “innovative,” more sophisticated methods are needed to find out who walks the walk and who just talks the talk. Narin thinks his research can help. Armed with refined stock-picking parameters, in July he launched Investor Tech-Line, a $15,000-a-year database that provides monthly rankings of 250 firms to institutional investors.

By comparing actual market-to-book values to his technology-based ratios, Narin classifies companies as overvalued or undervalued. To get an idea of the power of the approach, consider this: A portfolio of equal dollar investments in Narin’s 20 most undervalued stocks from last December 31 would have increased 50 percent over the next six months-a time when the S&P 500 rose only a few points. Beating the market by such a large factor “blows your mind away,” Narin says.

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