Innovation: A durable and differentiated investment theme

Innovation is, in our view, a repeatable source of competitive advantage, a measurable corporate behavior, and a persistent driver of excess return. According to our research, companies that invest effectively in innovation have often generated economic value that is not reflected in traditional accounting methods or style boxes. This difference may lead to a lasting investment advantage.

In our view, innovation should not be framed as a narrow thematic sleeve proxied by large‑cap growth. Innovation is broader and more durable. It spans sectors, styles, and market cap segments. Additionally, portfolio construction decisions matter materially for outcomes.

Innovation has historically been rewarded

Based on our analysis, innovation has historically been associated with higher returns. Figure 1 shows Russell 3000 stocks sorted by research and development (R&D)‑to‑equity into three groups, with a 4.8% annualized excess return spread between the high‑innovation and low‑innovation buckets from 1999 to 2025. When innovation is measured directly, increased innovation has been associated with better subsequent returns.

Academic papers find multiple possible explanations for an innovation premium. One explanation has been termed “creative destruction,” where economic growth is driven not by preserving existing business models, but by replacing them.¹ New technologies, products, and ways of organizing production displace older, less efficient incumbents. This allows innovators to capture excess profits. In practice, innovation creates value not only by adding something new, but by rendering prior solutions obsolete. This shifts market share, pricing power, and profit pools toward firms that adapt fastest.

Another model suggests that the uncertainty around the future profitability of an R&D investment may result in discounted stock prices.² R&D is expensive and takes time to realize results. For investors, R&D can be rather opaque, especially when intellectual property is involved and research is secretive in nature. Since investors cannot properly assess the probability of payoff, they adjust their discount factor to reflect the increased uncertainty of the outcome. This high discount can materialize as a premium for those investors willing to invest in the company.

(Fig. 1) Higher innovation stocks have historically delivered higher returns

Past performance is not a guarantee or a reliable indicator of future results.
Notes: All bucketing in this document is based on R&D to equity ratio. Returns are always the immediate month after rebalancing based on the ratio. Some companies do not report R&D expense, often due to sector convention. We bucket companies with income statement values but no R&D listed into a separate group.
At the end of each month, stocks that report R&D are sorted into three equal‑sized groups, with a fourth bucket for stocks not reporting R&D. High innovation is defined as companies that have the highest R&D‑to‑Equity ratio, and low innovation are companies that have the lowest R&D‑to‑Equity ratio. Bucket returns are calculated on an equal‑weighted basis. Accounting data are lagged 6 months to be consistent with literature. Compustat data are used for quarterly R&D values. Integrated Equity data are used for market cap.
Sources: T. Rowe Price analysis based on Russell 3000 data from 1999 to 2025. See Additional Disclosures.

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Innovation extends beyond growth

Innovation is frequently mislabeled as “just growth.” In our analysis, the high‑innovation bucket is almost evenly split between value and growth names: 51.37% value and 48.63% growth (see Figure 2). This supports our view that innovation is a cross‑style characteristic that can appear in businesses classified as value as well as growth, and shows that innovation‑oriented exposure can differ meaningfully from having exposure to a large‑cap growth index.

Value matters too for innovation

(Fig. 2) High‑innovation stocks are nearly evenly split between growth and value

Note: We use the Russell 3000 Growth and Value indexes to sort stocks into Growth and Value. For stocks that are in both indexes, we sort them into the style where more shares are held. Percentages are calculated on a market‑weighted basis. See Fig. 1 disclosure for additional methodology on the buckets.
Sources: T. Rowe Price analysis based on Russell 3000 data as of April 24, 2026.

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Innovation shifts across sectors over time

Nor is innovation confined to one sector or fixed in place. In Figure 3, the sector mix of the highest‑innovation bucket has changed materially over time. Innovation is better understood as a dynamic market structure than as a static sector label. Therefore, a flexible approach is key—one that is unconstrained by any single theme or sector and supported by active management, allowing investors to adapt as new technologies emerge and industries evolve. This results in differentiated sources of return that complement core equity holdings and offer the potential to improve long‑term returns.

(Fig. 3) Innovation is more than a sector

Note: Sectors are defined by Global Industry Classification Standard. High‑innovation bucket refers to the highest R&D‑to‑equity group among Russell 3000 stocks, formed monthly. Sector weights are calculated on a market‑weighted basis. See Fig. 1 for additional methodology on the buckets.
Sources: T. Rowe Price analysis based on Russell 3000 data and Global Industry Classification Standard from 1999 to 2025 (see sources for Fig. 1).

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Risk‑aware portfolio construction matters

Naïve portfolio construction can expose investors to unintended risk. Our analysis shows that within the highest‑innovation bucket, market cap weighting improved hypothetical long‑run outcomes versus equal weighting (see Figure 4). Portfolio design determines how much of the potential premium investors keep. In innovation, risk awareness is not a defensive add‑on; it is part of the alpha process.

Market weights can improve risk levels

(Fig. 4) Hypothetical growth of 100

Past performance is not a guarantee or a reliable indicator of future performance. The results shown do not reflect actual results achieved and are for illustrative purposes only. The high‑innovation bucket is not an actual investment or portfolio nor does it reflect fees or costs which, if deducted, would reduce results shown. The bucket cannot be invested into. Actual investment results associated with the innovation theme might differ, perhaps significantly.
We establish buckets using the methodology provided in Fig. 1. Using the High Innovation bucket, we evaluate two different weighting mechanisms, where weights are set at month end to either be equal or market weight.
Sources: T. Rowe Price analysis based on Russell 3000 data from 1999 to 2025 (see sources for Fig. 1).

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Innovation as an enduring allocation

Innovation is durable because it is rooted in how firms create future value. In our view, it works because successful innovators build intangible assets, widen competitive moats, and create earnings power that conventional accounting often understates. It is not just a style or sector, and portfolio construction plays a vital role for delivering the potential premium to investors.

Our work suggests that innovation can be measured, diversified, and differentiated. That supports the case for an innovation allocation that is enduring rather than fad‑driven, cross‑sector rather than theme‑concentrated, and distinct from large‑cap growth rather than redundant with it.