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Monday, August 22, 2011

For Bargain Stocks, Check the Patent Office

The Wall Street Journal
by Jack Hough
Aug 20, 2011

Anyone can spot a low price/earnings ratio. But figuring out which companies hold undervalued patents can provide a real investing edge.

Just this past week, Google agreed to pay $12.5 billion for Motorola Mobility, a struggling cellphone maker with a vast patent stash. Google had earlier been outbid by Microsoft, Apple and others on thousands of patents held by Nortel Networks, which is in bankruptcy.

For Bargain Stocks, Check the Patent Office.

These patent grabs suggest tomorrow's dominant smartphone or tablet is a three-legged stool built from software, hardware and communications—and companies are in a race to add rights to whichever legs they are missing. More broadly, big patent portfolios are increasingly being used as financial weapons.

A recent boom in patent sales is lifting patent values in general, says Nir Kossovsky, executive secretary at the Intangible Asset Finance Society, a Pittsburgh research group. And that is an opportunity for investors.

Figuring out which companies own which patents is easy. The U.S. Patent and Trademark Office digitized its records more than a decade ago. Putting a price on each patent is the hard part. You have got to project a patent's royalty streams, find similar patents that were sold recently or determine what it would cost to produce a similar patent.

Valuing just one patent can take weeks and cost tens of thousands of dollars, says Michael Friedman, a managing director at Ocean Tomo, a Chicago provider of patent services.

The Patent Board, a research group in Westmont, N.J., has an automated way of guessing which patents are most valuable: citation analysis. The more an existing patent is referred to in future patent applications, the more valuable it is presumed to be.

The research group doesn't publish patent values but rather ranks companies on "technology strength," which it bases in part on patent quality. publishes a Patent Scorecard for one industry each week based on these numbers. Cooper Industries, based in Dublin, ranked first among industrial components makers on a recent list.

"You can't know the exact value of a portfolio of patents, but you can make broad judgments," says Patent Board President Karl Wilhelm. "Eastman Kodak's patents are probably worth more than the company's recent value of a half-billion dollars. I can't imagine Apple's patents are worth more than $5 billion, and its value is more than $300 billion."

Of course, Apple's profits and pizzazz have a bigger influence on its stock performance than its patents, and making a patent-based bet on a company like Kodak is risky.

Mr. Friedman cites InterDigital, based in King of Prussia, Pa., as having the lowest market value among companies that can provide the third leg of Google's smartphone stool: high-speed communications patents. That is a tempting tip, but InterDigital's share price already has jumped more than 50% since mid-July to about $63, or 31 times projected 2011 per-share earnings—plenty pricey compared with most stocks.

A diversified basket of patent bets seems safer. The Guggenheim Ocean Tomo Patent exchange-traded fund is down 6.3% since its December 2006 inception, a better showing than the broad-market iShares S&P 500 ETF, which has lost 12.9%. The Guggenheim ETF is based on an Ocean Tomo index selected using a 56-ingredient recipe that helps computers guess which patents are most valuable.

With the stock market looking wobbly—or worse—and the threat of a double-dip recession looming, another tactic is to skim lists of patent-rich companies for ones with modest valuations, solid balance sheets and the ability to deliver handsome dividends, with or without a jump in the value of their patents.

Johnson & Johnson, Intel and Pfizer are among companies ranked top in their industries for technology strength by the Patent Board. The Ocean Tomo 300 Patent Index currently counts Microsoft, Royal Dutch Shell and IBM as its largest members. These six companies are on average one-quarter cheaper than the broad market based on earnings, and they yield an average of 3.6%.

For do-it-yourselfers, there is a patent-search tool at

One more factor bodes well for patent values: the recent rise of "nonoperating entities," or, less politely, "patent trolls." They grab patent portfolios for the purpose of suing other companies for violations and securing cash settlements.

That is forcing tech firms to scoop up idle patents defensively, creating a seller's market, says Jorge Torres, an intellectual-property lawyer in New York. So patent-stuffed companies might be richer than they look.