On the stock market, watch what they know, not what they do

It is no secret that technological skill can shape the future of the company.

However, it turns out that technological skill also creates hidden connections that can shape the future of companies that look completely different on the surface.

A new study led by Charles M.C. Lee, a professor of accounting at the Stanford Graduate School of Business, finds that cunning investors can use this technological proximity to predict how the stock price will perform in the coming months.

"Technological ability is driving growth, but these opportunities are not being isolated," Lee says. "There are overlapping technologies that are subject to general shocks and there are gaps in knowledge. Our main hypothesis is that investors do not quite understand these more bizarre relationships between companies. "

Lee is not talking about obvious similarities, such as between smartphone companies and wireless carriers, or between competing social media platforms.

Rather, it speaks of similarity in basic expertise, as it is reflected in the types of patents that companies receive.

A biotechnology company that manufactures pharmaceuticals is in a completely different business from a company that makes gene sequence analysis equipment. But if both companies have a large share of their patents in molecular biology, Lee says, they may be "technical peers" and be more interconnected than initially valued by investors.

If this is indeed the case, Lee theorizes, the stock market may be slow to make clear that the important news for a company is important for many of their hidden supporters. This would be an information lag and would create opportunities for discerning investors.

Companies that compete in different markets and industries, companies that you wouldn't think of as a denominator, are actually quite close in terms of their technological experience. Their path of life will move together.

"Our hypothesis was that when good things happen to your technology peers, it's likely to happen to your company," Lee says.

Lee and his colleagues - Stephen Teng Sung of Hong Kong City University, Rongfei Wang of Beijing University and Ran Zhang of China Investment Corp. in Beijing - confirmed their intuition by analyzing decades of historical data on technological proximity and stock returns.

The first step is to identify the technical partners based on how much their patents are concentrated in about 700 different technology categories.

The second step is to test the investment strategy by running thousands of computer simulations. Essentially, researchers are testing what would happen if they systematically bought or sold company stocks based on whether their technical partners' portfolios performed better or worse off the market.

And as expected, the study concluded that the strategy was talking. Holding long positions of companies with good technical links and short positions of companies with weak ones generates a monthly return that is 1.17% higher than for other investments with comparable risk factors.

According to the study, the strategy performs best by forecasting stock price movements over the next 6 months and not so well over a longer period.

Analysts also found that the investment strategy works better for companies that attract relatively little control from analysts and professional investors. This is because information lags become much shorter as more people pay more attention.

The big conclusion, according to Lee, is that technology companies can be both much alike and much different from what is seen on the surface.

"Companies that are in different markets and industries, companies that we don't assume can be put under a common denominator, can actually be quite close in terms of their technological development," Lee said.

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