Ask Moderna Inc. bulls how the money-losing biotech firm has just become a $28 billion stock, and they’ll play up its status as a frontrunner to deliver a drug that ends the pandemic.
While the company holds equipment and cash, what makes investors so willing to shell out is its promise in research and development. Yet under rules established since 1975, accountants treat R&D not as an asset of identifiable value on the balance sheet, but as an expense that reduces corporate earnings.
Now, big Wall Street names are pushing back. From MFS Investment Management to Wellington Management, they’re shaking up their investing models to make it easier to evaluate a Corporate America built on intangible assets -- brands and patents -- rather than physical items like factories and commodities.
“We’re now in a more service- and technology-oriented economy so it’s more important today to actually incorporate these measures of intangibles,” said Campbell Harvey, a senior adviser at quant firm Research Affiliates and professor at Duke University, on a recent webinar. Incorporating intangibles to book values leads to superior performance for systematic investors, according to Harvey.
That’s a big deal. If the idea catches on, it could transform financial analysis, rewrite quant models and reclassify hundreds of securities for investors of all stripes. With listed American firms excluding real estate and financial services spending an estimated $2 trillion last year on intangibles, more than double capital expenditure, the debate is firing up diverse constituents of the marketplace.
Forgotten Assets
Capitalizing things like trademarks and human talent on the balance sheet would make valuations for tech firms look somewhat more reasonable relative to their earnings or book value. Among America’s famously pricey tech giants, for instance, Research Affiliate’s calculations show the change would lower Amazon.com Inc.’s premium over the average large-cap from 982% to 340%, and Netflix Inc.’s from 1,138% to 759% as of Sept. 30.
No wonder traditionalists see a ruse to justify frothy tech shares. They fear that valuing intangibles is a guessing game, given the inherent uncertainty about their future worth.
Proponents say it’s all rooted in a larger mission: Reflecting an economy that’s less about the physical stuff and more about intellectual capital. After all, intangibles are now worth nearly 80% of tangibles in the U.S. market, compared to less than half before the 1980s. For growth shares, the former are now roughly 180% of the latter, according to Research Affiliates.
Heeding this trend has paid off for MFS Investment. Capitalizing R&D in tech and health care has been one of the top-performing value signals in recent years, says Noah Rumpf, director of quant equity research at the $548 billion firm. His team is now studying what expenses can proxy for intangible investments in other sectors.
The $1 trillion Wellington Management has also advocated the approach recently, while strategists at banks from JPMorgan Chase & Co. to Morgan Stanley are coaching clients on how to do it. Some firms have turned to alternative data such as patent registrations to refine their measurements.