There is a new innovation boom playing out in the United
States that has many positive implications for US equities. In July 2013, the BEA began including
investment in intellectual property in National Income and Product
Accounts. As part of this benchmark revision,
the BEA revised the US national accounts going back to 1947 to include some intangible
investments like research and development.
This new granular data on intellectual property investments reveals the current innovation boom.
As shown in the chart below, in the fourth quarter of 2014,
gross private domestic investment in intellectual property products contributed
41bps to US real GDP growth, the largest contribution since the first quarter
of 2000.
For perspective, gross private domestic investment in intellectual
property products is 4% of US real GDP, which compares to business fixed
investment in structures at 2.9% and equipment at 5.9%. US businesses spend roughly 30% more on
intellectual property than physical property.
Furthermore, US investment in intellectual property as a percent of real GDP has reached the peak
first achieved at the end of the 1990s tech boom.
In absolute dollars, the current rate of private US investment in R&D is $676.5 billion, some 50% higher than 2000 levels, The year over year rate of growth in intellectual property products is almost 7.5%, exceeding the growth rate in all other categories of fixed investment.
In R&D and Stock Returns: Is There a Spill-Over Effect?
(link to report), Yi Jiang examines the externalities of R&D
investments. His pioneering work builds
on the established body of work that suggests the market tends to under-react
to the benefits of R&D investments and that a firms’ R&D intensity is positively
related to subsequent stock returns. He
reaches several important conclusions in his paper, specifically:
1) Firms’ future operating performance is
positively related to peer firms’ R&D investments. Sales growth and gross margins are positively
correlated to industry peer R&D intensity.
2) Firms tend to experience positive abnormal
returns in the year following high peer R&D investments. This effect seems to last roughly one year.
3) Future earnings surprises and abnormal returns
around earnings announcements are significantly positive where peers have high
R&D investment levels. This effect
seems to last around two years.
4) Industry sales and employment grow faster when
industry R&D intensity is high, and the positive externality effect on
operating performance is stronger where the market expands more. One channel through which industry R&D
investments expand firms’ operating performance is via increased demand for the
whole industry (think smart phones or biotech drugs).
Taken together, this study would suggest that given the
breakout in gross domestic investment in intellectual property products, we are
in the period where these investments should lead to positive impacts on firms’
operating performance and abnormal returns.
In other words, the current innovation boom has positive implications
for investors in highly innovative companies.
The Gavekal Knowledge Leaders indexes (see here for more
information) are the first indexes to track innovative companies on a global
scale. We created these indexes as a way
to exploit the market’s inefficiency at incorporating data relating to company innovative
investments. Given the current
innovation boom, we believe investors should focus on the highly innovative
companies contained in our indexes. Please email us for more information at info@gavekal-usa.com.
