The Role of Intangible Investment in Predicting Stock Returns: Six Decades of Evidence

TL;DR

This study shows that intangible investment has become a significant predictor of stock returns since 1993, surpassing traditional factors like MTB ratio and profitability, based on six decades of data.

Contribution

It introduces an intangible intensity factor orthogonal to Fama-French factors and demonstrates its increasing predictive power over time.

Findings

Intangible investment's predictive power is weak before 1993.

Since 1993, intangible investment strongly predicts stock returns.

Intangible investment impacts both MTB ratio and operating profitability.

Abstract

Using an intangible intensity factor that is orthogonal to the Fama--French factors, we compare the role of intangible investment in predicting stock returns over the periods 1963--1992 and 1993--2022. For 1963--1992, intangible investment is weak in predicting stock returns, but for 1993--2022, the predictive power of intangible investment becomes very strong. Intangible investment has a significant impact not only on the MTB ratio (Fama--French high minus low [HML] factor) but also on operating profitability (OP) (Fama--French robust minus weak [RMW] factor) when forecasting stock returns from 1993 to 2022. For intangible asset-intensive firms, intangible investment is the main predictor of stock returns, rather than MTB ratio and profitability. Our evidence suggests that intangible investment has become an important factor in explaining stock returns over time, independent of other factors such as profitability and MTB ratio.