Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 165

Innovation offers opportunities for investors

Australia’s National Innovation and Science Agenda appears to have sharpened the focus on companies perceived as ‘innovative’ in nature. From an investment perspective, innovation represents opportunity. It also present risks, however, primarily for incumbents whose margins or market shares are threatened by new entrants or more innovative competitors.

By understanding the breadth of opportunities for new entrants in an industry, as well as the threats to incumbents, professional long-short investors are able to profit from opportunities on both sides of the ledger. In this article, we consider what innovation means in the Small Companies sector and how innovation and disruption can drive investment decisions in this often under-researched space.

What does disruption mean for small company investors?

The information technology age in which we live means many people associate innovation with something digital or online. Consider how innovative products like Uber and iTunes have revolutionised the taxi and music businesses. In fact innovation, and therefore disruption, is occurring in all kinds of businesses in Australia, across a wide range of sectors.

From an investment perspective, you need to consider much more than the innovation itself. Many other factors will determine whether an innovative company is a good investment such as the size of the market for the product or service. Then there are questions like:

  • are there barriers to entry or lack thereof?
  • how many years a product has been in development?
  • is it meaningfully different from competitors?
  • is it patented?
  • how much money has been invested in research and marketing?
  • how broad is the distribution footprint?

All of these considerations determine whether a company has competitive advantages and, importantly, the sustainability of those advantages over time.

There are also investment considerations for incumbent operators. Some of these established, listed companies may have been operating successfully in an industry for many years, with earnings streams that were previously deemed defensive and sustainable. For long-short investors, the potential negative effects of disruption can be as appealing as the potential benefits of innovation.

Innovation in established industries

In any industry, there is almost always some level of product development or innovation occurring. The car industry is one of the most established and competitive in the world and there is an astonishing level of innovation underway, including the development of electric motors and the release of prototype driverless vehicles.

For Australian small cap investors, there are exciting earnings opportunities from companies with innovative products and services in rather less futuristic areas.

In the 1970s, owners of 4x4 vehicles relied on homemade or ill-fitting equipment for use in rural or outback regions. At that time, ARB Corporation was established and the company started designing and producing a range of 4x4-related accessories. Following more than 40 years of product development and innovation, the company is a global market leader in the manufacture and supply of bull bars and other accessories. The 4x4 market is growing at a double-digit pace due to the ever-increasing popularity of SUVs and utility vehicles.

ARB currently exports to more than 100 countries, has a vast distribution footprint and owns its own outlets to service the aftermarket for additional, non-standard accessories. The global reach of this business model is not easily replicated. The company is on a strong financial footing, too. ARB is in a net cash position and earnings margins in the 20% range are the envy of companies in many other industry sectors.

Whilst many of ARB’s products are perceived to be innovative, the key appeal for us as investors is the sustainability of the competitive advantages developed over more than four decades.

Innovators completing Initial Public Offerings (IPOs)

Many of the most innovative companies are relatively immature, unlisted companies. Some of these go on to complete IPOs, crystallising gains for founders and seed investors and raising capital to fund future growth. An example in the Australian small cap sector is Reliance Worldwide Corporation, a recent IPO of a company operating in plumbing, an established and ‘old fashioned’ industry.

Among the company’s main products is a ‘push-to-connect’ pipe fitting. The product offers plumbers and DIY users an efficient, less labour-intensive solution to repairs following pipe leaks. While Reliance Worldwide has about 80% share in the push-to-connect market in the US, Canada and Australia, the real attraction is that push-to-connect currently only accounts for about 10% of the plumbing supply market in the US. The growth opportunity is significant and the company is experiencing sales growth of more than 10% per annum.

Reliance Worldwide has been distributing plumbing products into the US for more than 16 years and has market-leading positions in primary locations. Trademark protection of the product provides another important competitive advantage. Market share is protected from imitation products and, importantly, means Reliance Worldwide can maintain decent pricing power with stockists.

Will we continue to see innovative companies in Australia?

Given the National Innovation and Science Agenda of the Federal Government, we expect to see a steady stream of start-up companies threatening incumbent operators in many industries. Some of these companies will have aspirations to list and will go on to complete IPOs.

As pioneers such as REA Group (in real estate digital advertising) and TPG Telecom (in both internet and telephony services) have proved, disruptive companies with innovative products and services – combined with the right focus from a capable management team – can generate handsome returns for investors.

On the other hand, there have been countless examples of companies whose products and services have not lasted the test of time, resulting in a permanent loss of capital for investors. The challenge is to identify the key differences between the two and position your investment portfolio accordingly.

 

Dawn Kanelleas is Senior Portfolio Manager at Colonial First State Global Asset Management. This article is general information and does not consider the investment needs of any individual.

 

RELATED ARTICLES

Unearthing small and mid-cap gems

Thinking small to win big

Bounce back delivers super second-half for IPOs

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Investment strategies

Finding income in an income-starved world

With term deposit rates falling, bonds holding up but with risks attached, and stocks yielding comparatively paltry sums, finding decent income is becoming harder. Here’s a guide to the best places to hunt for yield.

Economy

Fearful politicians put finances at risk

A tearful Treasury chief, a backbench rebellion, and crashing bonds. What just happened in the UK and why could Australia’s NDIS be headed for the same brutal fiscal reality?

Shares

Investing at market peaks: The surprising truth

Many investors are hesitant to buy into a market that feels like it’s already climbed too far, too fast. But what does nearly a century of market history suggest about investing at peaks?

Shares

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Investment strategies

Will stablecoins change the way we pay for things?

Stablecoins have been hyped as a gamechanger for the payments industry. But while they could find success in certain niches, a broader upheaval of Visa and Mastercard's payments dominance looks unlikely.

Infrastructure

An investing theme you can bet on for the next 30 years

Investors view infrastructure as a defensive asset class rather than one with compelling growth prospects. These five tailwinds for demand over the coming decades suggest that such a stance could be mistaken.

Investment strategies

A letter to my younger self: investing through today's chaos

We are trading through one of history's most confounding market environments. One day, financial headlines warn of doomsday scenarios. The next, they celebrate a new golden age. How can investors keep a clear head?

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.