Eight months ago, I became a mom. Since then, my world has been taken over by every gadget, gizmo and child-holding contraption the baby industry has to offer. There are so many amazing products and services—and my fellow mommies and I didn’t have to ask for any of them! Thanks to the power of profit motive and a free market structure, companies have a huge incentive to develop awesome new child and baby essentials: profits! Capitalism fosters all the innovation and technological advancements that vastly improve our quality of life—and support stocks’ long-term growth.
Profits, after all, are what investors pay for when they buy equities—future profits, to be specific. But sometimes this gets lost when folks think about innovation—we think first and foremost on how advancements make our lives easier. For me, it is the Diaper Genie, which makes life a little less stinky. Or bottle warmers, which provide my munchkin a hot meal in a jiff. And, of course, the video baby monitor, which provides the peace of mind normal audio monitors often can’t—an invaluable benefit.
Perhaps, when you think about innovation, something else comes to mind—technological advancements aren’t just limited to new parents. Myriad innovations have added intangible benefits to everyone’s lives. Online video chats, for example, have largely replaced long distance phone calls to grandparents and relatives—more intimate and far less expensive than the old pay-per-minute structure of intricate and confusing long distance phone plans, leaving families with more money to spend elsewhere. Content streaming websites and movie rental kiosks remove a trip to the video store, saving gas and time, potentially leaving the family budget with a bigger buffer.
But these all provide new sources of corporate profits, too—they’re all new revenue streams. Which brings us back to profit motive. It is why companies strive to create new products and make existing products better. Without profit motive, goods might never evolve, and quality of life might never improve (and you probably wouldn’t be sitting there reading about stock investing)—there would be no incentive for any business or individual to take the financial risks necessary to develop something new. The bouncy chair is a great example. Babies have short attention spans. Bouncy chairs provide hours of entertainment, leaving mommies like me with free hands (and time) to do chores, relax or get a nap of our own. When I was young, my chair consisted of a metal frame and some fabric, and it relied upon my self-propelled motion. Fast forward 25 years and my daughter’s swing and bouncy chair play music, vibrate and provide lights and mobiles for their viewing pleasure (
some a lot of assembly required)—all because companies saw potential dollar signs in making this simple contraption snazzier. No one clamored for musical chairs, but businesses were willing to risk capital on developing and producing them, because they bet we’d want them once we saw them. And they were right!
And they got higher sales as a result—a key reason why innovation is an important contributor to stock returns over time. New and improved products mean new sources of revenues and profits over time. New products also give rise to new companies—even new industries—to service them or manufacture component parts, providing even more investment opportunities. And whole industries can use these new products and technologies to become more efficient, improving their bottom lines and adding to shareholder value. In fact, this is how investors can benefit directly from a new technology even if they don’t own shares of the companies that developed it (as is often the case when new technology is created by start-ups). 3D printing is a fantastic example. Investors who don’t want to concentrate in Industrials (which have underperformed lately) by investing directly in 3D printing start-ups can still capitalize on the technology by investing in the firms that use it to improve their own bottom lines. Many manufacturers, for example, use 3D printing to make production faster and cheaper.
Over time, there is no limit to what innovation and technology can do—or to how the onslaught of new ideas and creations can translate into future profits. Gordon Moore almost perfectly captured this idea in 1965, when he put forth the idea the number of transistors that would fit on a microchip would grow exponentially over time, helping electronics do far more for far less cost. New ideas and technologies we can’t even fathom today will collide in unpredictable ways to improve quality of life and provide new revenue streams for new and current businesses. Whether they produce electronics or bouncy chairs.
Ultimately, incentives matter. The potential payoff of profits to companies is often worth the risk of capital. As profit motive powers the never-ending cycle of innovation, parents like me benefit from fun, helpful products, and investors win by having an opportunity to invest in the companies that make them.