The index was created by Joseph Mezrich, Head of Quantitative Investment Strategy at Instinet. He examined the Russell 1000 companies and weighted them by the amount of their R & D expenditures expressed as a percentage of their total value compared to similar companies in their respective industries.
Mezrich's innovation index has also proven itself in the long run. He has dominated the broad market since 10, 20 and almost 40 years. Since 1990, the index of innovation has posted an average return of 20%, against 10% for the S & P 500 and 15.6% for the Nasdaq 100.
Mezrich told CNN Business that these results clearly show that investors are rewarding companies that are constantly looking for new products and means of growth, rather than companies that use their capital primarily to buy back shares. This last strategy can only give a short-term boost to a title.
"It's always good to innovate," said Mezrich. "A company must constantly decide to buy back more stock or invest in research. It's the tension."
Small businesses are great innovators
But innovation is not just about technology.
Take a look at the food industry, for example. Mezrich mentioned two companies that took opposite directions.
"One has invested in innovation and the other is not," said Mezrich.
Mezrich gave the example of two food companies whose stocks took opposite directions, mainly because one was more about cutting costs than new products, while the other was a leader in the booming market of plant-based foods.
In 2017, the company acquired the start-up Chicago Bar Company, specializing in the RXBar protein bar. Kellogg focused more on protein bars, nut spreads and other faster growing foods than packaged grains.
The old industrial companies succeed
Mezrich said the biggest surprise he found when he created the Innovation Index was the number of old industrial companies in it.
There is a larger percentage of basic material companies than computer hardware companies, for example. And capital goods companies have greater weighting in the index than software.
Although Deere shares fell 10% this year, AGCO is up 20%. AGCO has used augmented reality technology to help make tractors and also combines grain harvesting combines that can be used with touchscreen tablets.