The innovation frontier: The significance of patent data for investors

Among the key factors driving company growth and transformation, the one that typically stands head and shoulders above everything else is innovation. And innovation is pervasive across all sectors, business models, geographic regions, and customer bases.

How a company innovates can provide deep insights into future performance, helping investors improve their assessment of its potential. When a firm innovates or invents, it will often file a patent, to protect its legal rights to that idea – and the patent dataset is a compelling research resource. It offers comprehensive information on a company’s innovative activities, which can serve as a valuable indicator of future success across various industries and markets.

The patent dataset that we use is the largest we have ever handled, covering over 37 million entities, containing millions of pages of detailed filings, with each patent averaging around 50 pages. Processing such an immense volume of complex textual data presents significant computational challenges and requires leveraging recent breakthroughs in computing power to efficiently read, analyse, and extract meaningful insights. The advent of large language models further enables us to interpret and evaluate companies’ innovation level relative to their peers, transforming what would have been an otherwise insurmountable data processing task into a feasible analytical process that can help in making investment decisions.

Here, we look at the number of patent filings across time and geographies - focusing on the macro perspective, merely scratching the surface of the depth of information available. 

China overtaking the US

Exhibit 1, below, illustrates patent filings in emerging markets versus developed markets as a percentage of the total each year. It conveys a powerful message: innovation growth has shifted dramatically towards emerging markets, with an observable acceleration of this trend in the mid-2000s. 

Exhibit 2, below, depicts patent filings by the US and China as a percentage of their combined total. During the early 2000s, the US was dominant, but in the 2010s, China began filing extensively. Today, China accounts for approximately 80% of the combined filings between the two countries, reflecting a significant shift in the landscape of innovation.

From Exhibit 2 it is evident that the US alone can’t compete with China in patent activity, so in Exhibit 3 we explore whether the US and Japan or European countries could together overtake China in terms of patent filings. 

Exhibit 4, below, shows patent filings by each country as a percentage of the total filings by year. Several key insights can be gleaned from this chart. Notably, China has significantly transformed its patent landscape, particularly through technological advancement, and now dominates the number of new filings each year. Japan, on the other hand, shows a steep decline in filings, possibly due to the maturation of the domestic market and a shift in corporate research and development investments. The US has maintained its level of innovation activity but appears to have lost some ground, while Germany and France exhibit signs of stagnation. 

Investment implications

For investors, the primary takeaway is the growing significance of China and other emerging market countries in driving innovation. This trend highlights the potential for groundbreaking developments originating from China and presents potential attractive opportunities for returns in the region. 

China has caught up and exceeded the West in patent filings, while India lags due to a combination of factors. These include the lack of sufficient manpower to process patents, low private sector research and development spending, a largely service economy, as well as a stricter patentability criterion where India’s Patent Act has higher bars for patenting than the West. This is particularly visible in the pharmaceutical and software industries, to prevent so-called ‘evergreening’ (a practice that can delay generic competition) and protect public interest. As countries continue to support the commercialisation of their innovation pipeline, there may be yet greater gains to be had in emerging market economies.

While evaluating the volume of patent filings provides a useful measure of innovation, we can also assess the uniqueness and quality of innovation relative to peer companies. Using a proprietary model that combines Large Language Models with graph theory, we aim to identify innovative firms poised for significant growth that have the potential to become the market leaders. For investors, this can highlight potential investment opportunities and offer valuable insights for asset allocation decisions across markets.