How We Beat the Market By 60%

The Motley Fool Rule Breakers team is back on the road, this time to tour Silicon Valley and attend the Google I/O developer conference. In addition to dispatches like this one, look for special updates at the Rule Breakers site and get live coverage at @TMFRuleBreakers on Twitter.

People and companies are too specialized. Everybody's looking for that "you got chocolate in my peanut butter!" moment -- that serendipitous discovery that comes from bringing people and tech together -- yet fail to see that the process itself always has unintended consequences and there's often beauty and innovation in those moments.

Consider 3M (NYSE: MMM  ) . The company that invented Post-It notes didn't set out to create what we now call sticky pads. Rather, an enterprising employee, Art Fry, saw a need for the adhesive his chemist colleague, Dr. Spencer Silver, had created. Post-It Notes were the result.

Or what about Kellogg Co. (NYSE: K  ) ? The founding brothers intended to create a bland vegetarian food for sanitarium patients only to find that the wheat they were using had gone stale and flaky. A later switch to corn as the primary ingredient gave birth to what we know today as Corn Flakes.

There's also Listerine. The Johnson & Johnson (NYSE: JNJ  ) best seller for treating (ahem) bad breath was originally a surgical antiseptic that couldn't find a market. But then an advertising executive helped the inventor's son coin the faux medical term "halitosis" and the fearful tag line, "always a bridesmaid, never a bride," as if bad breath could keep the suitors away. We've been mouthwashing ever since.

In other words, innovation rarely happens according to plan. In an environment where R&D budgets are shrinking to boost earnings and manage quarterly targets, the pace of innovation tends to slow. And in fact, there's evidence that it has. According to one study by Pentagon physicist Jonathan Huebner, the pace of innovation per capita peaked in 1873 and has been declining ever since. We've been left with a flood of patent applications but a slower pace of real, important discoveries.

It's funny to us in this era of collaboration -- an epoch characterized as much by Facebook and Twitter as hybrid autos and on-demand TV -- that so many companies have tunnel vision. Research and development is no longer the blue sky effort it used to be; it's directive, long on D and short on R, and designed to look only two to three years ahead. Anything longer could jeopardize earnings targets. (Heavens!)

So you might imagine our delight at meeting with companies that take a longer view. This week we've been at Google's (Nasdaq: GOOG  ) annual I/O developer conference, where, if you listen to presenters, the stated goal is merely to get coders excited to create. It's also consistent with the company's well-known policy of giving engineers a day a week to work on blue-sky projects. The result? Google is creating the circumstances that could lead to serendipitous innovation.

We've also visited Pacific Biosciences of California (Nasdaq: PACB  ) , a company that unapologetically claims a disruptive innovation via real-time gene sequencing. Creating its PacBio RS machine brought together disciplines not normally found under one roof: enzymologists, laser techs, software jocks, and mechanical engineers who cribbed from the Phoenix Mars lander in creating their breakthrough design.

The resulting system could reinvent not just sequencing but other means used to diagnose disease and discover drugs. The trick is balancing the pursuit of that down-the-road vision with a need to sell the imperfect embodiment of the vision now.

It's no accident that Google and Pacific Biosciences are on our Motley Fool Rule Breakers scorecard. We've interested in the not-easily quantifiable because it's the companies bold enough to tread down unworn paths that unleash billions in value.

Will we make mistakes along the way? Of course, and so will the companies we invest in. The goal never, ever is to predict The Next Big Thing or lay unsustainable, crazy bets that look too much like lottery tickets. Rather, our aim is to align our investing dollars with the companies that cultivate discovery and commercial success. The best stocks -- the ones that have helped us outperform the S&P 500 by 60% -- are always bound to have both.

Do you agree? Disagree? Tell us how you approach investing in innovators using the comments box below. You can also rate Google or Pacific Biosciences in Motley Fool CAPS.

The Motley Fool recently introduced a free My Watchlist feature that allows users to stay ahead of the curve and receive up to date news on companies like Google, Pacific Biosciences or any of their competitors. Add these companies to your watchlist today:

Google and Pacific Biosciences are Motley Fool Rule Breakers recommendations. 3M, Google, and Johnson & Johnson are Motley Fool Inside Value picks. Johnson & Johnson and Kellogg are Motley Fool Income Investor selections. Motley Fool Options has recommended members create a diagonal call position in Johnson & Johnson. Motley Fool Alpha LLC owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days.

Fool contributors Tim Beyers and Karl Thiel are members of the Rule Breakers stock-picking team. Tim owned shares of Google, and Karl owned shares of 3M at the time of publication. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool is also on Twitter as @TheMotleyFool. Its disclosure policy hasn't seen nearly enough blue skies for May. Come on, Spring!


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