Think of it as autos vs. algorithms. The contribution by service and information industries to the U.S. economy has been increasing for decades, and severe downturns have a history of accelerating economic and social changes already afoot. When the Great Recession comes to an end, investors will likely find themselves in an investing landscape where a greater portion of the average company's value lies in its intellectual, rather than tangible, assets. At the close of the Great Depression, investing in Smokestack America was the smart move. Come the end of the current economic crisis, investors may want to bank on companies rich in intangible assets, such as patents and brands.
One way to search for such opportunities is to look for companies with low book value relative to stock price—or, to put it another way, a high price-to-book ratio. Book value represents the historical cost of a company's assets but may not represent true value. Price-to-book can help to uncover intangible assets that aren't valued on the balance sheet. Morningstar ran a screen for five-star stocks (those trading well below its estimate of what they're worth based on expected future cash flow) with premium price-to-book values compared with the average company in the Standard & Poor's 500-stock index.
Focusing on companies with promising patents is another way to find value. With almost 7 million patents filed since 1983, most don't have much value. But some companies do a great job monetizing innovation. IBM has earned some $10 billion in patent-related royalties since 1993. Ocean Tomo, a financial consulting firm specializing in intellectual property valuation, screened its proprietary database for BusinessWeek, looking for companies that have good potential for turning patents into profits and that don't seem overvalued. We then ran the list against the S&P star-rating system and chose the five highest-rated stocks.
Farrell is contributing economics editor for BusinessWeek. You can also hear him on American Public Media's nationally syndicated finance program, Marketplace Money, as well as on public radio's business program Marketplace. His Sound Money column appears on BusinessWeek.com.