Do Intangible Assets Explain the Failure of the Value Factor?Advisor Perspectives
Is the failure of the value factor over the last decade due to the inability of book value to incorporate so-called “intangible assets,” such as the intellectual property that has propelled companies like Amazon, Alphabet and Apple? New research provides the answer.
The value factor underperformed over the past decade, leading many to argue that a driver of value’s poor performance has been the deteriorating quality of book assets as a fundamental anchor due to the omission of internally generated intangible assets, which have become a steadily increasing percentage of corporate assets. As one example, Amitabh Dugar and Jacob Pozharny, authors of the 2020 study, “Equity Investing in the Age of Intangibles,” concluded that the relationship between financial variables and contemporaneous stock prices has weakened so much for high-intangible-intensity companies in both the U.S. and abroad that investors can no longer afford to ignore the changes in the economic environment created by intangibles.
Andrea Eisfeldt, Edward Kim and Dimitris Papanikolaou contribute to the literature with their August 2021 study, “Intangible Value.” They began by noting: “Correctly defining the fundamental anchor for the value factor is important both in the context of rational explanations of value, in which book assets capture assets in place, and for behavioral explanations, in which market to book ratios represent a measure of mispricing.” In support of this view, they cited research finding that intangibles had grown from about one-third of corporate assets in 2003 to about half – resulting in a growing mismeasurement of book assets. To address this problem, they proposed an intangible-augmented value factor (“intangible value,” HMLINT) – adding intangible assets to the book equity of each firm – and constructed it using a simple modification to the standard Fama and French value factor (HMLFF). They also performed their intangible value sort within industries.
Eisfeldt, Kim and Papanikolaou applied the perpetual inventory method to flows of 100% of selling, general and administrative (SG&A) expenses, given assumptions about depreciation and initial values to estimate the value of three main categories of intangibles: computerized information, R&D and economic competencies. Their measure of HMLINT added intangibles to book equity and subtracted goodwill. Their factor construction matched the original Fama and French data construction methodology as closely as possible. Their sample period was 1975 to 2018. Additionally, they conducted analyses for subperiods from 1995-2018 (post-internet era) and 2007-2018 (post-crisis era).
Read the full article here by Larry Swedroe, Advisor Perspectives