Intangibles and Expected Stock Returns

Abstract

Intangible assets have always been part of the economic landscape. In this study we examine the impact of intangibles, both internally developed and externally acquired, on our ability to identify differences in expected stock returns. Our research does not find compelling evidence that we should include estimates of internally developed intangibles in company fundamentals such as book equity. The estimation of internally developed intangibles contains a lot of noise. Perhaps due to this high level of noise, we find that estimated internally developed intangibles provide little additional information about future firm cash flows beyond what is contained in current cash flows. Moreover, capitalizing estimates of internally developed intangibles does not yield consistently higher value and profitability premiums. We also find no compelling performance benefit of excluding externally acquired intangibles from fundamentals. Therefore, we believe investors are better off continuing to incorporate externally acquired intangibles reported on the balance sheet and not adding noisy estimates of internally developed intangibles to value and profitability metrics.

Keywords: intangibles, intangible assets, expected returns, equities, value, R&D, profitability, factor investing, research and development

JEL Classification: E22, G12, G14, G31, G32, M41, O33