Intangible Capital and the Value Factor: Has Your Value Definition Just Expired?

Equity Investing in the Age of Intangibles

“…Our approach to this issue differs from that of Arnott et al (2021), Amenc et al (2020), and Li (2020), who attempted to adjust book values for the impact of unaccounted intangible capital, and from that of Angelopoulos et al (2012), who estimated industry-relative intangible intensity for companies in each industry. Although such methods can compensate for biases in valuation metrics that result from inadequate accounting of intangible capital, company-level estimates of intangible capital may be volatile and fraught with measurement error.…”

“…Moreover, capitalized intangible assets affect reported earnings over long periods as they are gradually amortized (expensed), although amortization practices vary by intangible type and by industry and country. Arnott et al (2021) and Amenc et al (2020) showed that adjustments to book value to account for the effect of intangibles do improve the return prediction ability of B/P for US companies, and Li (2020) confirmed this finding for companies in several international markets. Nevertheless, Arnott et al (pp.…”

“…Via their impact on reported earnings, intangibles and their inadequate accounting can also affect profitability characteristics, such as return on equity. The adjustments to B/P suggested by Arnott et al (2021), Amenc et al (2020), and Li (2020) provide no information about this issue. Our broad examination of whether the rise of intangibles has influenced the relationship between fundamental financial variables, such as book value and earnings, and contemporaneous stock prices can provide insights into these aspects.…”

“…Arnott et al (2021) used company-level estimates of intangible capital provided to them by Peters and Taylor (2017) to adjust the book values of US companies. Amenc et al (2020) made similar adjustments by using long histories of financial data and certain specific data items (e.g., industryspecific R&D depreciation rates from the US Bureau of Economic Analysis and the year of a company's founding). Because of limited international research on this subject, whether enough breadth and history of fundamental and macroeconomic data are available to permit making such adjustments in all or most international markets is unclear.…”

“…Because the validity of SG&A expenses as a proxy for intangible organization capital has been confirmed by multiple studies, we used the same approach. Note that Arnott et al (2021) and Amenc et al (2020), however, considered only 30% of the total SG&A expenses reported on income statements to be capitalizable intangible assets. Our research was unaffected by this design choice because we used SG&A expenses to rank and classify companies according to their organization capital rather than attempt to assess its value relevance or adjust book values by the amount of unrecorded organization capital.…”