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INTANGIBLE ASSETS

Measurement, Drivers, Usefulness


Working paper #2003-05
By

Feng Gu and Baruch Lev*

Boston University School of Management


Accounting
595 Commonwealth Avenue
Boston, MA 02215
gu@bu.edu
Phone: (617) 353-4985
Fax: (617) 353-6667

The authors are at Boston University and New York University, respectively. We are grateful to
participants at the 4th Intangibles Conference and the 2002 American Accounting Association annual
meeting and workshop participants at Osaka University for their helpful suggestions and comments. Feng
Gu acknowledges the financial support provided by Boston University, School of Management. Baruch
Lev retains exclusive rights to the measures described in this paper, and has a patent pending for them. The
measures should not be used or reproduced without a written permission from the author.

Abstract
The measurement and valuation of intangible assets are a matter of considerable
interest to managers, investors, and accounting-standard setters. Important decisions
concerning intangibles are hampered by the lack of systematic and comparable measures
for these increasingly important assets. In this study, we provide an approach to
estimating the value of intangible assets that are not recorded on the firms balance sheet.
The methodology is based on the economic notion of production function, where the
firms economic performance is stipulated to be generated by physical, financial, and
intangible assets. We estimate the contribution of intangible assets by subtracting the
normal returns on physical and financial assets from an earnings-based economic
performance measure. Capitalizing the expected value of this contribution over future
years yields an estimate of intangible capital.
We find compelling evidence that our approach provides economically
meaningful estimates of intangible assets. Our results indicate that investments in R&D,
advertising, brands, information technology, and human resource practices are important
drivers of intangible capital, and in turn corporate value. We find that intangibles
measures provide more value-relevant information than conventional performance
measures, such as earnings and cash flows. Furthermore, the approach is shown to be
useful to investors seeking information on future performance of valuable intangibles.
We document extensive evidence that the intangibles-based measures can effectively
distinguish between overvalued and undervalued stocks.
We believe the intangibles measures described here can add an essential, and
hitherto missing, valuation tool for managers and investors concerned with intangible
assets. The results on the value drivers of intangible can also be potentially useful to
regulators in identifying candidate disclosure items to be considered in their effort to
improve disclosure on intangibles.

Keywords:
Data Availability:

Intangibles, measurement, drivers, usefulness.


Data are available from sources identified in the text.

Intangible Assets: Measurement, Drivers, Usefulness


1. Introduction
It is widely accepted that intangible (or intellectual) assets are the major drivers of
economic growth in most economic sectors, but the measurement of these assets has
eluded so far managers, accountants, and financial analysts valuing investment projects.
Due to a lack of measure for these increasingly important assets, evaluating profitability
and performance of business enterprise by existing metrics (e.g., ROA, ROE) is seriously
flawed, since the value of firms major asset intangibles is missing from the
denominator of these indicators. Measures of price multiples are similarly misleading,
absent the value of intangible assets from accounting book values. Valuations for the
purpose of mergers and acquisitions are incomplete without an estimate of intellectual
capital. Resource allocation decisions within corporations similarly require values of
intangible assets. These and other uses create the need for valuing intangibles, in both
new and traditional economy sectors. In this study, we provide an approach to estimating
the value of intangible assets that are not recorded on firms balance sheet. Using this
approach, we empirically identify several categories of value drivers of intangible assets.
We also demonstrate the usefulness of this new methodology using investment analysis.
Intangible (knowledge) assets, such as new discoveries (drugs, software products,
etc.), brands or unique organizational designs (e.g., Internet-based supply chains) are by
and large not traded in organized markets, and the property rights over these assets are
not fully secured by the company, except for intellectual properties, such as patents and
trademarks. The risk of these assets (e.g., drugs or software programs under development

not making it to the market) is generally higher than that of physical assets.1
Accordingly, many, particularly accountants and corporate executives, are reluctant to
recognize intangible, or intellectual capital as assets in financial reports, on par with
physical and financial assets. While such attitude concerning balance sheets may be
understandable, it does not satisfy the need to seek information about the value of
intangible assets.
Some have attempted to gauge the value of intangibles from the difference
between the companys capital market value and its book value (the balance sheet value
of net physical and financial assets). This simple separation is unsatisfactory because it is
based on two likely flawed assumptions: (1) that there is no mispricing in capital markets,
and (2) that balance sheet historical values of assets proxy for their current values. The
market-minus-book approach to valuing intangibles is also unsatisfactory because it is
circulatory. One searches for measures of intangibles value in order to provide new
information to investors and managers. What is the use of a measure (market-minusbook) that is derived from what investors already know (market and book values)? There
is obviously a need for a more theoretically sound approach to estimating the value of
intangible assets.
Our methodology of estimating the value of intangible assets is based on the
classical economic theory of production function, where the firms economic
performance is stipulated to be generated by the three major classes of inputs: physical,
financial, and intellectual assets. In this formulation, the value of assets lies in their
ability to create earnings, in the past and especially in the future. A performance measure
1

See Lev (2001) for elaboration on the unique economic attributes of intangibles.

which is strictly based on past earnings or cash flows, or a modification of earnings (e.g.,
the various value added measures), misses a major part of what intangible assets are all
about creating future value and growth, by investment in R&D, brand enhancement, or
employee training. As such, our performance measure is an average of past and future
earnings. Under our approach, the value of intellectual capital is estimated by subtracting
the normal returns on physical and financial assets, from the economic performance
measure. The residual then becomes the contribution of intangible assets, which we
define as intangibles-driven earnings. Capitalizing the expected stream of intangiblesdriven earnings over future years yields an estimate of intangible capital. Details on
each step of the estimation procedure are provided in the next section of the paper.
We find compelling evidence that our approach provides economically
meaningful estimates of intangible assets. We document a high (and statistically
significant) correlation between the level and growth of intangibles-based measures and
various value-creating expenditures, including investment on R&D, advertising, and
capital improvement. The measure of intangible assets appears to capture activities that
are found to be the catalyst of growth and profitability of business enterprises, but are not
recognized as assets in financial reports. For several smaller samples (with several
hundred firms in each), we also find that intangibles-driven earnings and estimate of total
intangible assets are highly correlated with firm brand values, investment in information
technology, acquisition expense, and various human resource practices that enhance
firms human capital. When combined, these value drivers all have distinctive power in
explaining the estimate of intangible assets, suggesting that our approach indeed provides

a comprehensive and meaningful measure of value-creating intangible assets, which are


largely ignored by the current financial reporting system.
The advantage of the intangibles-based measure over the existing financial
performance measures is also reflected in its superior value-relevance to investors.
We find that intangibles-driven earnings have a much higher correlation with
contemporaneous stock returns than conventional performance measures, such as
accounting earnings and operating cash flows. For the period of 1989 to 1999, the
correlation coefficients are 0.53, 0.29, and 0.11 for the annual change of intangiblesdriven earnings, accounting earnings, and operating cash flows, respectively.
The strength of the correlation is much higher for firms with lower return-earnings
association, in high-tech (e.g., biotechnology and pharmaceutical, software) and
traditional industries (e.g., paper products, utilities, and retail) alike. The evidence
increases our confidence that our approach fills an important gap in the current financial
reporting system.
We also evaluate the potential usefulness of our approach to investors seeking
information on future performance of valuable intangible assets. In studying all public
companies with required data available from 1980 to 1999, we find that the ratio of
comprehensive value (equal to estimated value of intangibles plus the recorded book
value) to market value performs better than the book-to-market ratio, in identifying firms
with superior performance over the long-run. The predictive power is much more evident
for firms with relatively low book values, attesting to the measures ability to reflect the
value of unrecorded intangible assets.

The superior performance of the intangibles-based measure does not seem to be


explained by risk factors. After controlling for all risk factors practically known to affect
stock returns, the superiority of the comprehensive-to-market ratio still persists. We
document one-year excess returns of 3 percent for the quartile portfolio with the highest
ratio of comprehensive value to market value. Without portfolio re-balancing, the excess
return steadily grows to 4 percent and 5 percent for the second year and third year,
respectively, equivalent to compounded returns of 12 percent for a period of three years.
The evidence thus confirms the useful information captured in the measure of intangible
assets.
Our approach provides economically meaningful and useful estimates for the
value of intangible assets that are not shown by firms under the current reporting system.
Given the increasing importance of such assets in the economy, we believe the result has
the following implications. For managers engaged in the creation and management of
intangible assets, our approach can be used in making resource-allocation decisions of
intangibles and evaluating their performance. As demonstrated in this study and
elsewhere, existing financial measures cannot fulfill this role, because of the ignorance of
intangible assets in these measures. Our evidence also suggests that investors will likely
find the approach a useful tool for making investment decisions, especially when facing
the challenge of valuing companies with a substantial portion of assets not recorded
anywhere.
Finally, the results documented in this research are likely useful to accounting
standard-setters contemplating improved information disclosure about intangibles, amid
the increasing public concerns with the adequacy of such information (FASB 2001a,

2001b; SEC 2001). Our finding of excess future stock returns earned by firms with
valuable intangibles suggests that information relevant for future performance is not fully
shared with investors. In our view, this underlies the call for more information disclosure
on intangibles. Furthermore, the evidence on the value drivers of intangible assets can be
helpful for identifying candidate disclosure items worth consideration, given their
specific contribution to the value and growth of intangibles.
The remainder of this paper is organized as follows. In the next section, we
provide a detailed description of our methodology, followed by descriptive statistics of
intangibles estimates presented in section 3. Section 4 reports the association between
our intangibles-based measures and various value-creating expenditures that are believed
to be the drivers of intangible assets. In section 5, we evaluate the value-relevance of the
intangibles-based measures. In section 6, we use portfolio analysis to further demonstrate
the usefulness of our approach to investors seeking information on intangibles. Section 7
contains summary and conclusions.
2. Research methodology
The methodology for measuring the value of intangible assets is based on the
economic notion of production function, in which the firms economic performance is
assumed to be driven by three distinctive classes of assets: physical, financial, and
intangible (knowledge) assets. That is:
Economic Performance

= Physical Assets + Financial Assets +


Intangible Assets

where , , and represent the contributions of a unit of asset to the enterprise


performance. This formulation is a derivation of the classical growth theory in
economics (Solow, 1956, 1957).
A key ingredient in this approach is the definition of an enterprise economic
performance as an aggregate of past core earnings (earnings excluding unusual and
extraordinary items), and future earnings, or growth potential. A performance measure
which is strictly based on past earnings or cash flows, or a modification of earnings (e.g.,
various types of value added measures), likely misses a major part of what intangible
assets are all about creating future growth, by investment on R&D, employee training,
and the like. Past earnings are also included in the performance measure, because they
can potentially validate the likelihood of future earnings. We believe that the average of
past and future earnings, referred to as normalized earnings, is a better measure of the
firms economic performance, than either the past earnings or future earnings alone.
For the results reported in this paper, we use the same number of years (generally
3-5) for past and future earnings. We use two alternative approaches to estimate
expected earnings: consensus earnings forecasts by financial analysts, and an earnings
forecast based on the pattern of the firms past sales. Normalized earnings are thus an
annual weighted average of 6-10 earnings numbers, giving a heavier weight to expected
earnings.
Having thus defined enterprise performance, the next step is the measurement of
the performance drivers the three major asset groups. The values of physical (property,
plant, and equipment) and financial (cash, stocks, bonds, and financial instruments) assets
are obtained from the firms balance sheet and footnotes (with proper adjustments, such

as converting accounting historical costs to current values). The derivation of the value
of the third performance driver intangible capital is, in a sense, the solution to the
above production function for the one unknown (intangible capital). This is done by
estimating the normal rates of return on physical and financial assets the and
coefficients in the above production function. Based on estimates provided in previous
studies in economics and finance, we use after-tax rates of 7% for physical assets and
4.5% for financial assets, reflecting economy-wide averages. For company-specific
applications, the rates can be tailored to reflect firm-specific risk factors. The
contributions of physical and financial assets, namely the normal assets returns multiplied
by the values of physical and financial assets are then subtracted from the estimated
economic performance of the firm. What remains from this subtraction is the
contribution of intangible assets to the enterprise performance, which is defined as
intangibles-driven earnings (IDE).
Lastly, we forecast the series of intangibles-driven earnings over three future
periods based on a three-stage valuation model. For future years 1-5, we use financial
analysts long-term growth forecasts or a sales-based forecast. Through future years 610, linearly converging the forecasts to the long-term growth of the economy 3%.
From future years 11 to infinity, IDE are assumed to grow annually by 3% the expected
growth rate of the economy. The discounted value of expected IDE series, using a
discount rate that reflects the above-average riskiness of these earnings, yields the
estimate of intangible capital. The intangible value measurement procedure is
demonstrated graphically in Figure 1.

Once the values of intangibles have been estimated using this approach, the
results can be compared and combined with existing performance measures to give a
more complete portray of firm value. For example, the value of intangible capital can be
added to book value to yield an appraisal of the balance sheet that takes all corporate
assets into accounts, from tangibles such as machines to intangibles, such as patents and
know-how. This is defined as the firms comprehensive value.

3. Sample data and descriptive statistics


To estimate the values of intangibles, we use financial statement data from the
1999 Compustat merged annual files and earnings forecast data provided by I/B/E/S.
Stock price and returns data used in subsequent analysis is from the CRSP stock return
files. For the period of 1980 to 1999, a total of 28,883 firm-years have the required data
available from all three sources.
In Table 1, we report descriptive statistics of the intangibles-based measures
calculated by using the approach described in section 2. All numbers are computed for
the fiscal year 1999. To illustrate the cross-industry variation of the measure, we include
industry mean values for a total of twenty-four non-overlapping industries that have at
least 20 companies each year. We classify industries by both the 2-digit and 3-digit SIC,
to maximize the number of firms included in each industry and at the same time
minimize the within-industry differences across firms.
Table 1 shows substantial cross-industry variation in the amount of both
intangible capital and intangibles-driven earnings, which is obviously the joint effect of
differences in firm size and the intensity of intangibles. The ratio of intangible capital to

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book value, however, controls for the size effect and suggests the degree to which a
company is intangibles-based. The higher the ratio is, the more valuable are the firms
intangibles compared to its tangible assets. For almost all industries, the ratio is above
one, suggesting that on average unrecorded intangible assets are more valuable than the
historical book value of net assets recorded on balance sheets. The magnitude of the ratio
may be indicative of the extent to which the value of intangible assets is ignored in the
current reporting system.
As expected, the ratio of intangible capital to book value is generally higher for
knowledge-intensive or innovation-driven industries than others. The average ratio for
pharmaceutical companies (SIC of 283) is 6.14, the highest among all industries,
followed by medical instruments (SIC of 384) and computer software (SIC of 737).
Table 1 also indicates that many so-called old economy industries are rich in
intangibles as well. For example, the ratio is above 4 for food and beverage and apparel
and accessory store, for which brands and related assets (e.g., trademarks) are a form of
potent intangibles that may allow firms to earn a price premium on their products. To a
smaller extent, this is also true for printing and publishing (SIC of 27) and retailing
service (SIC of 59), both of which have a ratio above 2.5.
When these two alternative measures of firm value are compared to market value,
it reveals the distinctive role of recorded and unrecorded assets in investors assessment
of the firms value. The ratio of market value to book value, also known as the price
multiple, is substantially above one, indicating that investors placing value to be several
orders of magnitude larger than the accounting value of net assets recorded on balance
sheets. In fact, the ratio is even greater than 5 for several knowledge-intensive industries

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(e.g., pharmaceutics, software, communication equipment, and many others), suggesting


very little significance of the book value in market valuation. Although the statistics
reported here are calculated as of the end of the fiscal year 1999, the dramatic departure
of market value from book value over the last two decades has been extensively
documented in the financial press and many previous studies.2 Some have even cited the
change as a clear indication that accounting information has lost its relevance and
timeliness as the U.S. economy evolves from the industrial age to the information age.
The comprehensive value, the sum of intangible capital and book value, is much
closer to investors assessment of firm value, as shown by the more modest ratio of the
market value to comprehensive value. Even for the most knowledge-intensive industries
(e.g., software, electronic components, and drugs), the ratio is very close to one,
suggesting a much more robust view of corporate assets than balance sheets alone
convey.3 The close alignment between the market value and comprehensive value
indicates the economic significance of intangible assets in investors assessment of firm
value. In section 6, we will perform extensive tests to demonstrate the unique usefulness
of the measure reflecting intangible assets.
The last column of Table 1 presents the compound annual growth rate of
intangibles-driven earnings (IDE) for each industry over the period of 1990 to 1999.
Consulting services (SIC of 87), for which intangibles are likely the only meaningful
assets of many companies, shows the highest annual growth (31.1%). Special industrial
2

As of the date of this draft, the average market-to-book ratio for the S&P 500 is about 5.5, attesting to the
fact that investors perceived the corporate value missing from the balance sheet to be several orders of
magnitude larger than book value of net assets.
3
In unreported analysis, we find that the average ratio of market value to comprehensive value is 0.947 for
the twenty-year period from 1980 to 1999. The variation over time is relatively small, within a tight range
from 0.725 to 1.123.

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machinery (SIC of 355) and electronic components (SIC of 367) have the second and
third highest growth, respectively. Most traditional industries, on the other hand, have
only single-digit annual growth rate, possibly due to the more steady nature of their
intangible assets, such as brands and organizational capital.

4. Value driver of intangibles


Intangible (intellectual) capital is driven by diverse factors: innovation, human
capital, organizational processes, customer and supplier relations, to name some major
ones. For most of these drivers (e.g., customer satisfaction), there is no standardized,
public information available. We, therefore, limit the analysis here to several intangibles
drivers for which the information is publicly available: R&D, advertising (brand support),
capital expenditures, information systems, and technology acquisition. In this section, we
provide evidence on the association between these economic activities and the value of
intangible assets.
4.1 R&D, advertising, and capital expenditure
Prior studies have found that expenditures on R&D, advertising, and capital
improvement are associated with the creation of various types of intangibles.
Specifically, R&D is a major form of corporate intangibles investment, and its
contribution to productivity and growth has been extensively documented by prior
studies, at both firm and economy level.4 Although it is not recognized as assets under
the current accounting rules in the U.S., investors generally view the expenditure as
4

According to National Science Foundation estimates, in 2000, U.S. corporations spent a total of $181
billion on R&D, representing 3.3 percent of the GDP for nonfinancial corporations and 1.8 percent of total
GDP. This compares to 1.8 percent and 1 percent, respectively in 1978. For a summary of empirical

13

value-increasing investment (Lev and Sougiannis 1996). Advertising is an important way


to create and enhance brand awareness. Prior research finds that advertising expenditure
contains value-relevant information (Hirschey and Weygandt 1985), although the benefits
tend to be relatively short-lived (Bublitz and Ettredge 1989). Capital expenditure, for
some firms, includes intangibles embedded in physical assets (e.g., information system).
We predict a positive association between these expenditures and the value of intangible
assets.
We estimate the contribution of these drivers by regressing intangibles-driven
earnings (IDE) on advertising, R&D, and capital expenditure based on the following
model:
IDE i t

= a 0 + a 1 ADVT i t

+ a 2 RD i t

a 3 CAPEXP i t

e it

(1)

where ADVT is advertising expenditure, RD is R&D expenditure, CAPEXP is capital


expenditure, and i and t are firm and year subscript, respectively. All variables are
deflated by the book value of equity at the end of the prior fiscal year.
The regression results of equation (1) are reported in Table 2. In all regressions,
the coefficients on the three drivers are positive and statistically significant at the 0.001
level. In the first regression including all three drivers simultaneously, the coefficient
estimates indicate that for $1 investment on advertising, R&D, and capital expenditure,
the contribution to IDE is $0.131, $0.229, and $0.052, respectively. The magnitude is
relatively stable across regressions, indicating economically meaningful contributions
attributable to these drivers. The results are robust to alternative estimation procedure for
dealing with potential statistical problems (e.g., fixed-year and fixed-industry effects).
evidence on the association between investments in R&D and measures of productivity and growth, see

14

Similar results are also found in the regression of intangible capital (not reported here).
Our finding, therefore, indicates a strong association between the value of intangibles and
these drivers.
4.2 Brands
Brand names are important economic assets of many firms, although similar to
R&D, brands are generally not recognized as accounting assets under U.S. GAAP. This
is mainly due to the concern about whether brand values are reliably estimable. The
study of Barth et al. (1998), however, demonstrates that brand value estimates are
significantly positively associated with market values. They also find a positive effect of
brand values on operating margin and market share, a further indicator of the economic
value of brands. In our study, we assess the contribution of brand values to intangible
assets. As in Barth et al. (1998), we use estimated brand values published in
FinancialWorld.5
Table 3 reports the association between brand value estimates and the intangiblesbased measures. In Panel A, we present the correlation between brand values and the
intangibles-based measures. The correlation between brand values and both intangible
capital and intangibles-driven earnings is positive and statistically significant at the 0.001
level. In addition to total intangible capital, we also examine a measure of intangibles
other than R&D, calculated by subtracting from intangible capital an estimate of
capitalized R&D using an annual amortization rate of 20%. This aggregate of other
intangibles is found to have a higher correlation with brand values, suggesting that for the

Lev (2001) and Hall (1993).


5
For summary statistics on the estimated brand values used in this analysis and other firm characteristics,
see Barth et al. (1998).

15

firms included in this analysis, brands may represent a significant share of intangibles
other than R&D.
In Panel B, we report evidence on the contribution of brands to the value of
intangibles (VI), while controlling for the effect of R&D, by using the following model:
VI i t

= b 0 + b 1 RDCAP i t

+ b 2 BRAND i t

b 3 FOOD i t

v it

(2)

In equation (2), we use intangibles-driven earnings, total intangible capital, and intangible
capital adjusted for R&D capital to proxy for the value of intangibles, VI. RDCAP is the
estimate of R&D capital, BRAND is the brand value, and FOOD is a dummy variable
that equals one for firm-years from the food and beverage industry known for the
concentration of valuable brands (2-digit SIC of 20), and zero otherwise. As a
benchmark, we also include current earnings as another dependent variable to assess the
effect of brand values on firm performance. All variables are deflated by the book value
of equity at the end of the prior fiscal year.
We find a positive and statistically significant coefficient on brand values in all
regressions. The magnitude of the coefficient, however, varies with the choice of the
dependent variable. The coefficient in the regression of earnings is 0.061, somewhat
smaller than the coefficient of 0.078 in the regression of intangibles-driven earnings. The
regression results for intangible capital suggest that an investment of $1 in brands
generates approximately $1.02 worth of intangibles, and the effect becomes stronger
($1.267) when R&D-related intangibles are excluded. The coefficient on R&D capital is
considerably larger than brands in all regressions, suggesting a higher productivity

16

associated with investment on R&D.6 The dummy variable, FOOD, is significant only
when brand value is omitted from the model. The R2s of the model also improve when
brand values are included, again indicating their significant contribution to the
explanatory power of the model. The evidence, therefore, has identified brands as value
drivers of intangibles.
4.3 Human resource practices
Corporations invest considerable resources in their employees, through jobtraining, incentive-based compensation plans (employee stock options), knowledge and
information sharing systems, and others. In fact, many companies frequently claim in
their annual reports and other media that employees are their most important assets.
However, empirical research on the contribution of human resource practices to firm
profitability and market values is extremely rare, due to the nonexistence of publicly
disclosed information on such practices. As a result, it remains difficult to gauge the
benefits from expenditures on human resources, separately and in comparison with other
value-creating expenditures such as R&D.
In this study, we use a proprietary database on management compensation
packages to investigate the contribution of human resource practices to overall intangible
assets. The database provides details of compensation for individual managers at all
levels for nearly 500 large publicly traded companies over the period of 1996 to 1999.
Two specific measures are of main interest in our analysis: long-term incentive pay
(LPCT) and annual bonuses (BPCT), as percentages of base salaries. The long-term
incentive pay includes, among other things, mainly employee stock options. Based on
6

This is consistent with the difference in net present value (NPV) of advertising and R&D expenditure

17

definition of management responsibilities in terms of sales, average values of these two


variables are calculated at three aggregate levels: high, middle, and low level of
management.
The results of our evaluation are provided in Table 4. In Panels A and B, we
report the mean and median values of LPCT and BPCT for middle-level management,
along with other intangibles drivers identified so far, for firms ranked by the value of
intangibles-driven earnings and intangible capital, respectively. We find that firms with
more aggressive compensation practices also have higher intangibles values, as well as
higher market-to-book ratios and stock returns, suggesting positive economic benefits
accrued from incentive-based compensation practices.7 However, expenditures on R&D,
capital improvement, and personnel (proxied by selling, general, and administrative
expense (SGA)) also vary in the same direction.
To assess the incremental value of the human resource practices, we control for
the effect of these other value drivers using the following regression model:
VI i t

= c 0 + c 1 RDCAP i t

+ c 2 CAPEXP i t

+ c 4 LPCT i t + c 5 BPCT i t

c 3 SGA i t

+ u it

(3)

where the value of intangibles (VI) is represented by intangibles-driven earnings and


intangible capital, RDCAP is R&D expenditure, CAPEXP is capital expenditure, SGA is
selling, general, and administrative expense, LPCT is the percentage of long-term
incentive pay, BPCT is the percentage of bonus, and u is an error term.

documented by Hand (2000).


7
Univariate correlation analysis confirms a positive association between compensation practices and
intangibles value, market-to-book ratio, and stock returns (not reported here).

18

Panel C of Table 4 reports the regression results based on equation (3). We


estimate the model separately for high-level and middle-level management. The
coefficients on R&D and SGA are positive and statistically significant at the 0.001 level
in all regressions. The coefficient on capital expenditure, however, is mixed, possibly
due to the small size of the sample in our analysis. For the regression of intangiblesdriven earnings, the coefficients on LPCT and BPCT are also positive and significant at
the 0.001 level. The effect of incentive-based compensation appears much stronger for
middle-level management than high-level management. At both levels, the inclusion of
these variables also increases the R2 of the model considerably. Together, these value
drivers explain more than 40% of the variation in intangibles-driven earnings and
intangible capital. Results for the regression of intangible capital are similar, except the
insignificant coefficient on BPCT. The evidence, therefore, shows that investment on
human resources in the form of incentive-based compensation creates valuable
intangibles.
4.4 Investment in information systems and technology acquisition
Organizational capital represents another important form of intangibles. Similar
to human capital, there is generally very little disclosure by corporations on
organizational capital. Here we focus on one form of such investment: acquisition of
computer-related and other technologies. The study of Brynjolfsson and Yang (1999)
documents that spending on information technology is positively associated with market
value of firms, suggesting economic benefits attributable to such investment by creating
more efficient and productive business organizations.

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In Table 5, we provide evidence on the association between the level and growth
of intangibles-driven earnings and spending on information technology and technology
acquisition. Data on information technology spending is from the Computer Intelligence
Infocorp database, which details information technology spending for Fortune 1000
companies. The data source of technology acquisition is the SDC database.
In Panel A, we report the mean values of spending on information technology and
technology-related acquisition for firms divided into quartiles based on the current level
of intangibles-driven earnings (deflated by sales). We also include the mean value of
other value drivers such as expenditure on R&D, advertising, and capital improvement.
We find that firms with larger spending on information technology and technology
acquisitions are associated with greater intangibles-driven earnings and higher stock
returns, suggesting that such expenditure has positive contribution to the value of
intangibles and corporation. Similar results are found in Panel B where firms are divided
into quartiles based on the one-year-ahead change of intangibles-driven earnings. The
evidence, therefore, is consistent with organizational capital being an important form of
intangibles.8
In summary, we have empirically documented a strong association between the
value of intangible assets and investments in a diverse set of drivers, including R&D,
advertising, capital improvement, brand enhancement, human resource practices, and
acquisition of information-related and other technologies. This is just the beginning of a
detailed identification and quantification of the drivers of intangible capital, and in turn,
8

In unreported tests, we find that the correlation between these two expenditures and IDE are positive and
statistically significant. We also estimate a model similar to equation (3), with the spending on information

20

corporate value. We believe such a mapping is important, as business and investment


decisions are predicated on the understanding and quantification of the major drivers of
corporate value and growth.

5. Value-relevance of intangibles-based measure


We assess the value-relevance of the intangibles-based measures by correlating
them with contemporaneous stock returns, in comparison with conventional performance
measures, such as earnings and cash flows from operating activities. If the intangiblesbased measures capture more value-relevant information, they would have a higher
correlation with returns than earnings and operating cash flows.
The superiority of the intangibles-driven earnings (IDE) in reflecting timely
performance information is suggested by results reported in Table 6. The correlation
coefficients are calculated for the period of 1989 to 1999, because prior to 1989 data on
operating cash flows were not available on Compustat. For the annual change of
intangibles-driven earnings calculated using earnings forecasts by financial analysts
(termed IDE (AF)), the correlation with annual stock returns is 0.53, much higher than
the correlation for earnings (0.29) and operating cash flows (0.11).9 When IDE are
calculated using a mechanical sales-growth model (termed IDE (SF)), the correlation
coefficient drops to 0.40, although the measure still outperforms earnings and operating
cash flows.10

technology and technology-related acquisitions included along with R&D, advertising, and capital
expenditure. The coefficients on these two variables are positive and statistically significant.
9
All correlation coefficients in this analysis are statistically significant at the 0.001 level.
10
The advantage of earnings over cash flows is, of course, consistent with the finding of prior studies that
accounting income is a better performance measure than cash flows.

21

Table 6 also presents the correlation coefficients at 2-digit SIC industry level. We
include a total of 36 industries, ranked by the correlation between earnings and returns.
While the correlation based on earnings ranges from 0.05 to 0.59, the correlation based
on IDE (AF) shows a much smaller variation across industries, ranging from 0.25 to 0.77.
The reduction in the variation suggests that incorporating the value of intangible assets
results in more comparable performance measures across industries.
The advantage of IDE over earnings is most noticeable for industries with
relatively low return-earnings association, such as construction and grocery stores, for
which the correlation based on IDE is as high as 0.46, compared to less than 0.1 for
earnings. In such cases, the magnitude of the correlation based on IDE is much more in
line with industries with higher return-earnings association (e.g., food and beverage). For
a total of twelve industries (e.g., paper products, software, health services, and chemical
and drugs), both technology-driven and traditional, IDE more than doubles earnings, in
terms of the correlation with stock returns. When IDE are estimated using the sales
growth model, for most industries it also has a stronger correlation with contemporaneous
returns than earnings and operating cash flows, again indicating the superiority of the
intangibles-based measures.
In Table 7, we assess the incremental information contained in IDE while
controlling for the information content of earnings. This is done by regressing annual
stock returns on the level and change of earnings and IDE simultaneously by using the
following model:
RET i t = d 0 + d 1 EARN i t + d 2 EARN i t + d 3 IDE i t + d 2 IDE i t + i t,

22

(4)

where RET is the stock return calculated for the period from three months after the end of
the prior fiscal year to three months after the end of the current fiscal year, EARN is
reported earnings (before extraordinary items and discontinued operations), EARN is
the annual change of reported earnings, IDE is intangibles-based earnings, IDE is the
annual change of IDE, and is an error term.
Consistent with the results of correlation reported in Table 6, IDE has a much
larger coefficient than earnings, for both the level and change variables, regardless of the
estimation procedure of future earnings. An F-test indicates that the difference between
the two performance measures is significant at the 0.001 level. The R2s of the model also
improve considerably when IDEs are included in the model, suggesting significant
enhancement to the explanatory power of the model attributable to the variable. It thus
appears that IDE provides substantially more relevant information to investors than
reported earnings. The difference is likely due to the fact that IDE focuses on the
contribution of intangibles arguably the major catalyst for growth, whereas earnings
focus more on the historical performance of all assets, including those with low
contribution to growth.11
The results in Table 7 are robust to a variety of sensitivity tests. The coefficient
estimates are relatively unchanged by alternative estimation procedure (e.g., inclusion of
fixed-year and fixed-industry effects or year-by-year regression). Result of additional
diagnosis does not indicate the existence of influential outliers or other statistical

11

In an unreported test, we regress price per share on earnings per share, book value per share, and
intangible capital per share to evaluate the incremental information contained in intangible capital estimate.
We find that the coefficient on intangible capital is much larger than book value, consistent with this
measure containing more value-relevant information.

23

problems. Estimating the model at industry level also gives very similar results (not
reported here).
In summary, the evidence reported thus far indicates that compared to
conventional performance measures, intangibles-based measures contain more useful
information to investors. Higher cross-sectional comparability in performance measure is
also achieved by incorporating the value of the firms economic assets not recorded in
current financial reports. In our view, the intangibles-based measures offer a more
comprehensive and timely reflection of the firms economic performance.

6. Predictive power of intangibles-based measure


The analysis in section 5 indicates a strong contemporaneous correlation between
stock return and growth in intangibles-driven earnings. The evidence, however, is
insufficient to infer that information on intangibles can predict future performance. In
this section, we focus on the prediction of future returns using comprehensive value (sum
of book value and intangible capital). This analysis is necessary for further evaluating
the usefulness of the measure to investors.
We compare the performance of a trading strategy based on the ratio of
comprehensive value to market value with a strategy based on the book-to-market ratio
(B/M). As before, the intangible capital is estimated by using analyst earnings forecasts
and a sales-growth model. Thus, for the comprehensive-value-to-market ratio, we report
two sets of results: one based on earnings forecasts by analysts (CAF/M), and the other
based on the sales-growth model (CSF/M).

24

Table 8 reports characteristics of the quintile portfolios formed on the basis of the
three ratios. The portfolios are constructed by sorting all sample firms into quintiles at
the end of the third month after the fiscal-year end. For each portfolio, we report the
average B/M, CAF/M (CSF/M), and average buy-and-hold return over the next 12
months (12M Return), 24 months (24M Return), and 36 months (36M Return),
respectively. To maximize the comparability of the results over different holding
periods, we include only 22,173 (21,907) firm-years for which sufficient data is available
to calculate the return and CAF/M (CSF/M) ratio for all three holding periods. The last
column of Table 8 shows the differences in means between the top (Q5) and bottom (Q1)
quintiles, with the level of statistical significance marked to the right.
Panel A reports the performance of the B/M strategy. There is a monotonic
relation between B/M and future returns across quintiles. The lowest B/M quintile firms
earn an average return of 13.9% over the next 12-months, while the highest B/M quintile
firms earn 19.6%. The difference of 5.7% is statistically significant at the 0.001 level
using both parametric and non-parametric tests. For the next 24-months and 36-months,
the difference grows to 10.8% and 10.5%, respectively. The pattern and magnitude of the
return across quintiles are comparable to previous studies employing the same data to
evaluate the B/M effect over earlier periods (e.g., Frankel and Lee 1998; Dechow and
Sloan 1997).12
Panel B shows that CAF/M portfolios behave similarly to B/M portfolios. There
is also a monotonic relation between CAF/M and future returns, showing that CAF/M
12

These studies also included the characteristics of firm size and beta, which are found to be associated
with future returns. We performed the same analysis and found similar distribution statistics for them. A

25

also predicts returns. However, prediction results for CAF/M, measured by the
difference in mean returns between the highest and lowest CAF/M quintiles, are better
than results for B/M. The return spread between the highest and lowest CAF/M
portfolios is 8.6%, 17.1%, and 25.8% for the next 12-months, 24-months, and 36-months,
respectively, compared to the return spread of 5.7%, 10.8%, and 10.5%, respectively for
the B/M portfolios. The superiority of CAF/M appears to grow larger for longer
horizons.
Similar prediction results for CSF/M are shown in Panel C. Like CAF/M, CSF/M
also outperforms B/M in predicting future returns over both short and long horizons.13
The return spread between the highest and lowest CSF/M quintiles is, however, slightly
smaller, possibly due to errors and noise attributable to the use of a mechanical salesgrowth model in forecasting future earnings.
Table 9 is structured similarly to Table 8, except that the return is cumulated over
a 12-month period for each of the next three years (without portfolio rebalancing). Here
too, we find that on a year-by-year basis, CAF/M and CSF/M are better predictors of
future return than B/M. The predictive power of B/M, however, deteriorates over time,
as the return spread between the highest and lowest B/M portfolios declines from 5.7% to
3.8% and to 0.2% over the three-year period. A similar pattern is also seen for CAF/M
and CSF/M, but less dramatically. The return spread is positive and statistically

more robust control for the effect of these two variables is included in our estimation of future excess
returns.
13
The similarity between CAF/M and CSF/M is not surprising, given the high correlation between the two.
In unreported tests, we find that the Spearman rank correlation between CAF/M and CSF/M is 0.93
(significant at the 0.001 level). Because the portfolios are formed on the basis of quintile ranking, similar
prediction results for CAF/M and CSF/M are expected.

26

significant for the CAF/M and CSF/M strategies in each year, compared to only year t+1
and t+2 for the B/M strategy.
The results reported thus far show that CAF/M and CSF/M are better predictors of
short-term and long-term returns than B/M. We next evaluate the incremental
explanatory power of CAF/M and CSF/M for future returns, while controlling for the
effect of B/M. Specifically, we independently sort firm-years into quintiles on the basis
of CAF/M (or CSF/M) and B/M as of three months after the fiscal-year end. Stocks are
then assigned into one of 25 portfolios based on the ranking of these two ratios.
Table 10 reports the mean values of future return of the 25 CAF/M B/M
portfolios, for the next 12-months, 24-months, and 36-months, respectively. It shows that
CAF/M has strong predictive power in all five B/M quintiles, except portfolio Q4 in
Panel A. The difference in Q5-Q1 returns across B/M portfolios is statistically
significant and economically meaningful. The bottom row in each panel shows that the
B/M effect survives only in one or two CAF/M quintiles. The results thus indicate that
once the CAF/M effect is accounted for, the B/M effect essentially disappears.
Table 10 also shows that the superiority of CAF/M is more pronounced for firms
with lower book-to-market ratios. Low book-to-market ratios are likely the result of the
required immediate expensing of intangibles expenditure (e.g., R&D) and/or possible
overpricing. Our finding indicates that for such firms, incorporating the value of
intangibles can effectively distinguish between overvalued and undervalued stocks, for
both short and long horizons. The usefulness of the comprehensive value, therefore,
seems greater when the current reporting system is more deficient in recognizing the

27

value created by investment in all forms of intangibles. In our view, this is exactly what
such a measure should achieve.
Table 11 reports average future returns of 25 CSF/M B/M portfolios. Results
are mostly similar to those in Table 10. Again, we find that CSF/M has predictive power
for future returns, and it dominates the B/M effect by a large margin. The consistency of
CSF/M results suggests that the usefulness of the comprehensive value is not entirely due
to the use of earnings forecasts by analysts.14
Previous studies show that long-term returns are also associated with firm size
and market risk (beta) (Fama and French 1992). We next incorporate firm size and
market return, as well as B/M, in a more comprehensive evaluation of the usefulness of
CAF/M and CSF/M in predicting future returns. Specifically, we estimate post-portfolio
formation excess returns using the widely accepted 3- or 4-factor model (Fama and
French 1993) as follows:
r p t = p + p MRET

+ p SMB

+ p HML t + 2 RM t + p t,

(5)

where r p t is the portfolio p return in excess of the one-month T-bill return, MRET is the
excess return on a value-weighted aggregate market return, SMB is the return on a valueweighted, zero investment, factor-mimicking portfolio of firm size, HML is the return on
a value-weighted, zero investment, factor-mimicking portfolio for the book-to-market
14

Prior research has used analyst earnings forecasts to estimate firm fundamental value based on the
residual income model. One such study is Frankel and Lee (1998) that uses the EBO value to predict future
returns. Besides the difference between the economic concepts of residual income and comprehensive
value, a number of distinctive patterns in empirical results are noteworthy. First, the firm value estimate in
Frankel and Lee (1998) tends to underperform the book-to-market effect in short-term, but outperform it in
long-term. In ours, the comprehensive value dominates book value for all horizons. Second, they find that
the incremental power of the fundamental firm value estimate in predicting future returns is the highest for
portfolios with the lowest and highest book-to-market ratios (Panel B, Table 4). Our results show that the
predictive power of the comprehensive value is the greatest for firms with the lowest book-to-market ratios
(Tables 10 and 11).

28

equity, RM is the one year momentum in stock returns, measured as the difference
between the equally-weighted average return of firms with the highest 30% eleven-month
returns lagged one month, and the average return of firms with the lowest 30% elevenmonth returns lagged one month, and p t is an error term. These factors were found in
previous studies to be systematically associated with stock returns (e.g., Fama and French
1993; Jegadesch and Titman 1993).
Our focus in this analysis is on the estimated intercept, coefficients in equation
(5), which indicate the monthly risk-adjusted excess returns. For each year, we construct
quartile portfolios on the basis of CAF/M (or CSF/M), as of three months after the fiscalyear end. Each portfolio is held for the next three years, with monthly excess return
estimated for each year using equation (5).
Table 12 reports the estimate of future excess return during each of the three
subsequent years, for CAF/M and CSF/M, respectively. Overall, portfolios with higher
CAF/M or CSF/M earn larger excess returns over all horizons, and the return spread
between the highest and lowest quartiles is statistically significant at conventional levels,
except for CSF/M of the second year. Panel A shows that for the highest CAF/M
portfolio, the monthly excess return is 0.236 percent for the first year, equivalent to 3
percent on an annual basis. The amount grows to 0.278 percent (4 percent on an annual
basis) and 0.344 percent (5 percent on an annual basis), for the second year and third
year, respectively. Together, the compound risk-adjusted return over the three-year
period is about 12 percent. Similar results are found in Panel B showing that high
CSF/M portfolios consistently earn positive and economically meaningful abnormal
returns in future years. The pattern and magnitude of the excess return reported here are

29

comparable to results of recent studies examining the market valuation of intangibles,


such as R&D (e.g., Chan et al. 2001).
Summarizing, the extensive, large sample empirical tests reported in this section
indicate that the comprehensive-value-to-market metric, based on either analysts
forecasts or on a sales growth model, exhibit a consistent ability to generate subsequent
abnormal stock returns, whether evaluated against a book-to-market strategy, or a
combination of risk factors. We have found robust evidence that the intangibles-based
measure can effectively distinguish between overvalued and undervalued stocks over
short-term and long-term.

7. Summary and conclusions


The measurement and valuation of intangibles are a matter of considerable
interest to managers, investors, and accounting-standard setters. Important decisions
concerning intangibles are hampered, to all, by the lack of systematic and comparable
measures for these increasingly important assets. In this study, we have evaluated an
approach to estimating the value of intangible assets that are not recognized in financial
reports.
We document evidence suggesting that the approach provides economically
meaningful estimates of intangible assets. Our results indicate that investments in R&D,
advertising, brands, information technology, and various human resource practices are
important drivers of intangible capital, and in turn corporate value. We find that
intangibles measures provide more relevant information than conventional performance
measures, as indicated by the strength of correlation with stock returns. Furthermore, the

30

approach is shown to be useful to investors seeking information on future performance of


valuable intangibles. We document extensive evidence that intangibles-based measures
can effectively distinguish between overvalued and undervalued stocks. The relevance
and usefulness of the intangibles measure are most evident in circumstances where the
existing measures are most inadequate in reflecting the value created by intangible assets,
thus attesting to the success of the measure in filling an important gap in the current
reporting system.
We believe the intangibles-based measures described here can add an essential,
and hitherto missing, valuation tool for managers and investors concerned with intangible
(intellectual) assets, and with the optimal resource allocation of intangible and tangible
assets. Also the results on the value drivers of intangibles can be potentially useful to
regulators in identifying candidate disclosure items to be considered in their ongoing
effort to improve information disclosure on intangibles.
Lastly, the data and findings reported above are based on publicly available
information, and uniform return and discount rates. It can be expected that substantially
improved results will be obtained by tailoring the intangibles-based measures to the
specific circumstances of companies, subsidiaries, or stocks.

31

References

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market valuation. Review of Accounting Studies. 3: 41-68.
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Bublitz, B., and M. Ettredge. 1989. The information in discretionary outlays: Advertising,
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Chan, L.K.C., J. Lakonishok, and T. Sougiannis. 1999. The stock market valuation of
research and development expenditures. Forthcoming, Journal of Finance.
Dechow, P. M., and R. G. Sloan. 1997. Returns to contrarian investment: Tests of the
nave expectations hypothesis. Journal of Financial Economics 43: 3-27.
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Fama, E. F., and K. R. French. 1993. Common risk factors in the returns on stocks and
bonds. Journal of Financial Economics. 33: 3-56.
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FASB (Financial Accounting Standards Board). 2001b. Proposal for a new agenda
project: Disclosure on information about intangible assets not recognized in
financial statements.
Frankel, R., and C. M. Lee. 1998. Accounting valuation, market expectation, and cross
-sectional stock returns. Journal of Accounting and Economics. 25: 283-319.
Hall, B. 1993. Industrial research during the 1980s: Did the rate of return fall? BPEA:
Microeconomics, 289-393.
Hand, J. 2000. The net present value and returns-to-scale of intangibles and recognized
assets for publicly traded U.S. firms, 1980-1998. Working Paper, University of
North Carolina, Chapel Hill.

32

Hirschey, M., and J. J. Weygandt. 1989. Amortization policy for advertising and research
and development expenditures. Journal of Accounting Research 23: 326-335.
Jegadesch, N., and S. Titman. 1993. Returns to buying winners and selling losers:
implications for stock market efficiency. Journal of Finance. 48: 65-91.
Lev, B. 2001. Intangibles: Management, measurement, and reporting. Washington, D.C.:
Brookings Institution Press.
Lev, B., and T. Sougiannis. 1996. The capitalization, amortization, and value-relevance
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SEC (Securities and Exchange Commission). 2001. Strengthening financial markets: Do
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Economic Studies. 39: 321-330.

33

Figure 1

INTANGIBLE ASSETS

Past Earnings

Future Earnings

Normalized Earnings
Subtract:

Return on Physical Assets

Subtract:

Return on
Financial Assets

Equal:

Capitalize:

Intangibles-Driven Earnings

Intangible Capital

34

Table 1: Industry Average Intangibles-Driven Earnings and Intangible Capital for Fiscal Year 1999

SIC

Industry

13
20
27
28
283
33
34
355
357
366
367
371
382
384
421
451
481
49
50
56
581
59
737
87

Oil and gas


Food and beverage
Printing and publishing
Chemical (without 2834)
Drugs
Primary metal
Fabricated metal
Special industry machinery
Computer
Communication equipment
Electronic components
Motor vehicles
Scientific instruments
Medical instruments
Trucking services
Airline
Telephone communications
Electricity and gas utility
Wholesale of durable goods
Apparel and accessory store
Restaurants
Retailing service
Software
Consulting services

Number
of Firms
80
67
40
141
99
60
43
33
76
74
100
42
51
80
24
21
40
115
72
42
34
75
246
45

Intangible
Capital
($ millions)

IntangiblesDriven
Earnings
($ millions)

1,274
6,653
2,340
3,617
9,508
1,347
2,140
1,434
5,235
5,332
3,567
5,710
941
1,283
349
2,313
12,923
1,755
775
1,564
1,169
924
2,747
850

43
317
135
199
472
62
98
68
205
190
207
378
36
49
21
121
823
119
86
81
67
30
119
30

* Ratios are equal to sum of the numerator divided by sum of the denominator.
** For the period of 1990 - 1999.

35

Intangible
Capital /
Book Value *

1.72
4.24
2.62
1.80
6.14
1.78
3.82
4.26
3.40
4.48
2.99
1.48
4.25
5.35
1.74
1.45
0.94
1.03
1.81
4.31
2.13
2.53
4.84
4.37

Market
Market Value /
Value /
Comprehensive
Book Value *
Value *

2.61
5.45
3.01
3.30
9.19
2.60
3.49
6.39
6.35
9.41
7.50
1.94
4.10
6.59
1.56
1.70
3.41
1.69
1.77
4.49
3.97
3.83
10.87
3.96

0.96
1.04
0.83
1.18
1.29
0.94
0.72
1.21
1.44
1.72
1.88
0.78
0.78
1.04
0.57
0.69
1.75
0.83
0.63
0.85
1.27
1.08
1.86
0.74

Compound
Annual
Growth Rate
of IDE **
(%)
9.9
6.7
8.1
4.4
13.7
3.7
11.5
24.3
19.4
18.9
24.2
16.6
17.1
13.1
11.8
17.9
12.2
5.8
9.5
5.1
4.8
2.0
17.6
31.1

Table 2: Regression Results of Major Intangible Value Drivers


Independent Variables
Dependent Variable

Obs.

Intercept

ADVT

RD

CAPEXP

Adj. R

0.052
(0.0001)

0.16

Intangibles-Driven Earnings (IDE)

4,270

0.029
(0.0001)

0.131
(0.0001)

0.229
(0.0001)

Intangibles-Driven Earnings (IDE)

5,434

0.047
(0.0001)

0.115
(0.0001)

0.291
(0.0001)

0.11

Intangibles-Driven Earnings (IDE)

15,019

0.054
(0.0001)

0.324
(0.0001)

0.12

Intangibles-Driven Earnings (IDE)

8,562

0.061
(0.0001)

Intangibles-Driven Earnings (IDE)

22,820

0.048
(0.0001)

Intangibles-Driven Earnings (IDE)

11,891

0.037
(0.0001)

0.135
(0.0001)

0.01

0.301
(0.0001)

0.049
(0.0001)

0.05

0.041
(0.0001)

0.18

ADVT is advertising expenditure, RD is R&D expenditure, and CAPEXP is capital expenditure. All variables are deflated by the book value of
equity at the end of the prior fiscal year.

36

Table 3: The Association between Intangibles-based Measures and Brand Value Estimate *
Panel A. Correlation Coefficients between Brand Value and Intangibles-based Measures
Pearson

Spearman

Intangible Capital (IC)

0.31
(0.0001)

0.44
(0.0001)

Adjusted Intangible Capital **

0.63
(0.0001)

0.47
(0.0001)

Intangibles-Driven Earnings

0.33
(0.0001)

0.54
(0.0001)

Intercept

RDCAP

BRAND

Intangibles-Driven Earnings

0.166
(0.0001)

0.397
(0.0001)

Intangibles-Driven Earnings

0.061
(0.0001)

0.277
(0.0001)

Intangible Capital (IC)

-2.403
(0.0042)

13.499
(0.0001)

Intangible Capital (IC)

-3.921
(0.0001)

12.146
(0.0001)

Adjusted Intangible Capital

1.643
(0.2417)

-0.903
(0.7440)

Reported Earnings

0.167
(0.0001)

0.236
(0.0001)

Reported Earnings

0.076
(0.0001)

0.155
(0.0001)

Panel B. Regression results


Dependent
Variable

FOOD

Adj. R

0.102
(0.0186)

0.10

-0.039
(0.2174)

0.54

2.766
(0.0544)

0.09

1.017
(0.0001)

1.234
(0.3831)

0.16

1.267
(0.0001)

-0.373
(0.8591)

0.09

0.106
(0.0019)

0.06

0.015
(0.5730)

0.47

0.078
(0.0001)

0.061
(0.0001)

All variables are deflated by book value at the beginning of the fiscal year. "FOOD" Dummy equals to
one for firm-years from the food and beverage industry (2 digit SIC of 20), and zero otherwise.
* Brand value estimate is provided by FinancialWorld (1992 - 1997).
** "Adjusted Intangible Capital" is equal to Intangibles Capital (IC) minus R&D Capital, estimated by
using an annual amortization rate of 20%.

37

Table 4: The Association between Intangibles-Based Measures and Human Resource Variables
Panel A. Ranking by Intangibles-Driven Earnings (deflated by Sales) for Management Level = MIDDLE
Group

MTB

IC

IDE

RETURN

RD

CAPEXP

SGA

LPCT

BPCT

8.122
4.042
2.141

2.746
1.117
0.360

0.125
0.055
0.014

0.266
0.123
0.025

0.072
0.037
0.031

0.282
0.250
0.256

0.310
0.210
0.178

81.659
63.067
42.232

40.154
33.583
32.782

6.038
2.744
1.881

2.403
1.020
0.322

0.104
0.056
0.020

0.204
0.016
-0.095

0.055
0.021
0.008

0.229
0.212
0.194

0.295
0.189
0.144

64.074
41.319
35.451

34.755
30.950
24.577

Mean Values
HIGH
MIDDLE
LOW
Median Values
HIGH
MIDDLE
LOW

Panel B. Ranking by Intangible Capital (deflated by Sales) for Management Level = MIDDLE
Group

MTB

IC

IDE

RETURN

RD

CAPEXP

SGA

LPCT

BPCT

7.490
4.649
2.172

2.929
1.048
0.244

0.120
0.054
0.019

0.218
0.098
0.096

0.071
0.036
0.034

0.281
0.265
0.242

0.304
0.220
0.173

84.445
54.587
48.242

39.386
33.269
33.999

5.828
2.823
1.921

2.430
1.033
0.262

0.103
0.055
0.020

0.171
0.018
-0.025

0.052
0.023
0.009

0.230
0.232
0.176

0.301
0.214
0.128

65.613
42.862
36.294

32.483
29.774
27.414

Mean Values
HIGH
MIDDLE
LOW
Median Values
HIGH
MIDDLE
LOW

38

Panel C. Regression results for ALL years --- High v.s. Middle levels
Dependent Variable

Level

Intercept

RD

CAPEXP

SGA

Intangibles-driven Earnings

High

0.034
(0.001)

0.457
(0.001)

-0.009
(0.86)

0.100
(0.001)

Intangibles-driven Earnings

High

0.020
(0.001)

0.427
(0.001)

-0.028
(0.001)

0.122
(0.001)

Intangibles-driven Earnings

Middle

0.037
(0.001)

0.421
(0.001)

-0.009
(0.81)

0.099
(0.001)

Intangibles-driven Earnings

Middle

0.022
(0.001)

0.333
(0.001)

-0.030
(0.01)

0.104
(0.001)

Intangible Capital

High

0.323
(2.45)

11.894
(0.001)

0.690
(0.01)

2.496
(0.001)

Intangible Capital

High

0.259
(1.73)

10.261
(0.001)

0.032
(0.11)

2.983
(0.001)

Intangible Capital

Middle

0.341
(2.50)

10.507
(0.001)

0.633
(0.01)

2.634
(0.001)

Intangible Capital

Middle

0.222
(1.49)

8.577
(0.001)

0.163
(0.55)

2.638
(0.001)

LPCT

BPCT

Adj. R
0.36

0.001
(0.001)

0.014
(0.001)

0.44

0.31

0.028
(0.001)

0.021
(0.01)

0.42

0.36

0.061
(0.001)

0.019
(0.21)

0.44

0.34

0.771
(0.001)

-0.334
(0.14)

0.42

IDE is intangibles-driven earnings, IC is intangible capital, MTB is the market-to-book ratio, RETURN is stock returns over the fiscal-year, RD is
R&D expenditure, CAPEXP is capital expenditure, SGA is selling, general, and administrative expense, LPCT is long-term incentive pay as a
percentage of base salaries, and BPCT is bonus as a percentage of base salaries.

39

Table 5: Major Intangible Value Drivers


Panel A. The Mean of Intangible Value Drivers for Quartiles Ranked by Intangibles-Driven Earnings
Quartiles Ranked by the Level of Current Intangibles-Driven Earnings (deflated by Sales)

1st Quartile
2nd Quartile
3rd Quartile
4th Quartile

Intangibles-Driven
Earnings /
Sales

Average
Annual Return

R&D/
Sales

Advertising /
Sales

Capital Spending /
PPE

IT Spending /
Sales

Acquisition /
Sales

(%)

(%)

(%)

(%)

(%)

(%)

(%)

1.5
4.0
7.4
32.1

10.5
17.1
20.5
28.3

3.2
3.9
5.9
10.4

3.0
3.6
3.8
4.3

28.9
32.0
36.9
54.0

2.3
2.4
2.5
3.8

17.9
23.6
26.4
25.4

Panel B. The Mean of Intangible Value Drivers for Quartiles Ranked by One-Year-Ahead Growth of Intangibles-Driven Earnings
Quartiles Ranked by One-Year-Ahead Percentage Change of Intangibles-Driven Earnings

1st Quartile
2nd Quartile
3rd Quartile
4th Quartile

Change of
Intangibles-Driven
Earnings for
Next Year

R&D/
Sales

Advertising /
Sales

Capital Spending /
PPE

IT Spending /
Sales

Acquisition /
Sales

(%)

(%)

(%)

(%)

(%)

(%)

6.8
19.6
39.6
465

4.6
4.8
5.6
8.6

4.1
4.0
3.5
3.3

31.8
35.0
46.2
48.5

2.6
2.4
2.6
2.7

22.3
24.6
28.9
41.4

Value of Current Year

40

Table 6: Comparison of Value-relevance of Alternative Performance Measure


Correlation with Stock Returns
SIC

Industry

15
54
48
78
26
28
49
73
87
51
59
50
80
34
38
27
20
37
25
42
39
33
36
29
13
63
23
22
58
35
24
56
30
45
57
53

Construction
Grocery stores
Telecommunication
Motion pictures
Paper products
Chemicals & drugs
Utilities
Software
Consulting services
Nondurable wholesale
Miscellaneous Retail
Durable wholesale
Health services
Fabricated metal
Instruments
Publishing & printing
Food & beverage
Transportation equipment
Furniture & fixtures
Trucking
Manufacturing
Primary metal
Electronics
Oil refinery
Oil & gas
Insurance
Apparel
Textile
Restaurants
Computer & machinery
Lumber & wood
Apparel retailing
Rubber & plastic
Airlines
Home furniture store
Department store

Total

EARN

I DE (AF)

I DE (SF)

CFO

167
185
574
119
376
1,487
1,596
1,397
213
313
385
538
335
343
1,131
404
584
586
232
177
204
487
1,471
258
617
866
213
219
346
1,343
154
245
242
204
158
218

0.05
0.07
0.08
0.12
0.15
0.16
0.19
0.23
0.26
0.28
0.28
0.28
0.29
0.29
0.30
0.31
0.31
0.31
0.32
0.34
0.34
0.35
0.37
0.39
0.39
0.39
0.41
0.41
0.41
0.41
0.42
0.42
0.44
0.54
0.55
0.59

0.46
0.46
0.25
0.42
0.50
0.40
0.38
0.48
0.51
0.42
0.50
0.56
0.58
0.58
0.61
0.57
0.48
0.54
0.47
0.56
0.59
0.56
0.66
0.51
0.58
0.50
0.62
0.67
0.62
0.66
0.57
0.77
0.57
0.66
0.74
0.68

0.21
0.30
0.13
0.29
0.14
0.23
0.30
0.36
0.27
0.30
0.37
0.43
0.44
0.37
0.43
0.40
0.38
0.38
0.44
0.37
0.41
0.42
0.49
0.37
0.50
0.41
0.56
0.52
0.49
0.50
0.46
0.59
0.50
0.54
0.66
0.58

-0.07
0.18
0.10
0.18
0.12
0.13
0.08
0.11
0.10
-0.09
0.01
-0.14
0.17
0.10
0.13
0.25
0.13
0.09
0.14
0.30
0.10
0.11
0.16
0.10
0.35
0.19
0.04
0.20
0.37
0.17
0.17
0.38
0.05
0.41
0.30
0.14

23,130

0.29

0.53

0.40

0.11

IDE (AF) is intangibles-driven earnings estimated using earnings forecasts by analysts, IDE (SF) is
intangibles-driven earnings estimated by sales-growth model, EARN is reported earnings (before
extraordinary items and discontinued operations, and CFO is cash flows from operating activities.

41

Table 7: Regression of Contemporaneous Stock Returns on Earnings and Intangibles-Driven Earnings


Intercept

EARN

EARN

28,883

0.133
(0.001)

0.626
(0.001)

0.887
(0.001)

28,883

0.035
(0.001)

0.466
(0.001)

28,883

0.080
(0.001)

0.480
(0.001)

28,883

0.129
(0.001)

0.534
(0.001)

28,883

0.133
(0.001)

0.369
(0.001)

28,883

0.077
(0.001)

0.227
(0.001)

0.406
(0.001)

28,883

0.089
(0.001)

0.286
(0.001)

0.173
(0.001)

Obs

IDE (AF)

IDE (AF)

IDE (SF)

IDE (SF)

Adj. R

0.08

1.886
(0.001)

0.09

1.580
(0.001)

0.08

4.070
(0.001)

0.17

3.533
(0.001)

0.795
(0.001)

3.435
(0.001)

0.11

0.19

0.869
(0.001)

2.937
(0.001)

0.12

The dependent variable is stock return calculated for the period from three months after the end of the prior fiscal-year to three months after the end of
the current fiscal-year. EARN is reported earnings (before extraordinary items and discontinued operations, EARN is the change of earnings (EARN),
IDE (AF) is intangibles-driven earnings estimated using earnings forecasts by analysts, IDE (AF) is the change of IDE (AF), IDE (SF) is intangiblesdriven earnings estimated by sales-growth model, and IDE (SF) is the change of IDE (SF). The p-value of the t-statistics is included in parentheses.

42

Table 8: Future Stock Returns of Portfolios formed by B/M, CAF/M, CSF/M


Panel A Book-to-Market (B / M) Portfolios

B/M
CAF / M
12M Return
24M Return
36M Return
# of Obs.

Q1
(Low B / M)

Q2

Q3

Q4

Q5
(High B / M)

All Firms

Q5 - Q1
Difference

0.22
1.20
0.139
0.312
0.516
4434

0.41
1.37
0.145
0.331
0.511
4435

0.57
1.58
0.151
0.332
0.518
4435

0.76
2.08
0.157
0.362
0.569
4435

1.25
2.16
0.196
0.420
0.621
4434

0.64
1.68
0.158
0.352
0.547
22173

1.03
0.96
0.057
0.108
0.105

***
***
***

Panel B Comprehensive-to-Market (CAF / M) Portfolios (based on analyst forecast)

B/M
CAF / M
12M Return
24M Return
36M Return
# of Obs.

Q1
(Low CAF / M)

Q2

Q3

Q4

Q5
(High CAF / M)

All Firms

Q5 - Q1
Difference

0.56
0.25
0.122
0.289
0.460
4434

0.54
1.09
0.133
0.292
0.457
4435

0.57
1.42
0.154
0.345
0.533
4435

0.65
1.86
0.172
0.372
0.567
4435

0.88
3.75
0.208
0.460
0.718
4434

0.64
1.68
0.158
0.352
0.547
22173

0.32
3.50
0.086
0.171
0.258

***
***
***

Panel C Comprehensive-to-Market (CSF / M) Portfolios (based on sales forecast model)

B/M
CSF / M
12M Return
24M Return
36M Return
# of Obs.

Q1
(Low CSF / M)

Q2

Q3

Q4

Q5
(High CSF / M)

All Firms

Q5 - Q1
Difference

0.58
0.50
0.129
0.289
0.465
4381

0.50
0.95
0.133
0.302
0.487
4382

0.56
1.23
0.153
0.337
0.512
4381

0.67
1.60
0.170
0.373
0.581
4382

0.91
2.86
0.204
0.457
0.692
4381

0.64
1.46
0.158
0.352
0.548
21907

0.33
2.36
0.075
0.168
0.227

Portfolios are formed at the end of the third month after the fiscal-year end and held for the next 36
months. B/M is the book-to-market ratio, CAF/M is the ratio of comprehensie value (based on earnings
forecasts by analysts) to market value, and CSF/M is the ratio of comprehensive value (based on a
sales-growth model) to market value. ***, **, * signifies significance levels of 0.001, 0.01, and 0.05
respectively, for the t-test.

43

***
***
***

Table 9: Future Stock Returns of Portfolios formed by B/M, CAF/M, CSF/M


Panel A Book-to-Market (B / M) Portfolios

B/M
CAF / M
t+1 Return
t+2 Return
t+3 Return
# of Obs.

Q1
(Low B / M)

Q2

Q3

Q4

Q5
(High B / M)

All Firms

Q5 - Q1
Difference

0.22
1.20
0.139
0.155
0.154
4434

0.41
1.37
0.145
0.159
0.127
4435

0.57
1.58
0.151
0.160
0.153
4435

0.76
2.08
0.157
0.178
0.167
4435

1.25
2.16
0.196
0.193
0.156
4434

0.64
1.68
0.158
0.169
0.152
22173

1.03
0.96
0.057
0.038
0.002

***
***

Panel B Comprehensive-to-Market (CAF / M) Portfolios (based on analyst forecast)

B/M
CAF / M
t+1 Return
t+2 Return
t+3 Return
# of Obs.

Q1
(Low CAF / M)

Q2

Q3

Q4

Q5
(High CAF / M)

All Firms

Q5 - Q1
Difference

0.56
0.25
0.122
0.153
0.132
4434

0.54
1.09
0.133
0.147
0.134
4435

0.57
1.42
0.154
0.169
0.148
4435

0.65
1.86
0.172
0.174
0.155
4435

0.88
3.75
0.208
0.203
0.189
4434

0.64
1.68
0.158
0.169
0.152
22173

0.32
3.50
0.086
0.050
0.057

***
***
***

Panel C Comprehensive-to-Market (CSF / M) Portfolios (based on sales forecast model)

B/M
CSF / M
t+1 Return
t+2 Return
t+3 Return
# of Obs.

Q1
(Low CSF / M)

Q2

Q3

Q4

Q5
(High CSF / M)

All Firms

Q5 - Q1
Difference

0.58
0.50
0.129
0.150
0.136
4381

0.50
0.95
0.133
0.155
0.145
4382

0.56
1.23
0.153
0.160
0.142
4381

0.67
1.60
0.170
0.176
0.158
4382

0.91
2.86
0.204
0.204
0.178
4381

0.64
1.46
0.158
0.168
0.152
21907

0.33
2.36
0.075
0.054
0.042

Portfolios are formed at the end of the third month after the fiscal-year end and held for the next 36
months. B/M is the book-to-market ratio, CAF/M is the ratio of comprehensie value (based on earnings
forecasts by analysts) to market value, and CSF/M is the ratio of comprehensive value (based on a
sales-growth model) to market value. ***, **, * signifies significance levels of 0.001, 0.01, and 0.05
respectively, for the t-test.

44

***
***
***

Table 10: Future Stock Returns of the B/M - CAF/M Portfolios


Panel A: 12-Month-Ahead Portfolio Return
CAF/M

Comprehensive-to-Market (CAF/M)

Book-to-Market

Q1
Q2
(Low CAF/M)

Q3

Q4

Q5
(High CAF/M)

All Firms

Q1 (Low B/M)

0.111
(1297)

0.123
(1349)

0.155
(974)

0.159
(552)

0.253
(262)

0.139
(4434)

0.142

**

Q2

0.093
(903)

0.127
(999)

0.165
(1130)

0.148
(931)

0.230
(472)

0.145
(4435)

0.137

***

Q3

0.121
(860)

0.120
(772)

0.133
(961)

0.177
(1113)

0.204
(729)

0.151
(4435)

0.083

**

Q4

0.150
(773)

0.141
(646)

0.143
(812)

0.161
(977)

0.177
(1227)

0.157
(4435)

0.027

Q5 (High B/M)

0.157
(601)

0.170
(669)

0.180
(558)

0.210
(862)

0.218
(1744)

0.196
(4434)

0.062

All Firms

0.122
(4434)

0.133
(4435)

0.154
(4435)

0.172
(4435)

0.208
(4434)

0.158
(22173)

0.046

0.046
*

0.025

0.051
*

-0.034

B/M Q5 - Q1
Difference

Q5 - Q1
Difference

Portfolios are formed at the end of the third month after the fiscal-year end and held for the next 36 months. B/M is the book-to-market
ratio and CAF/M is the ratio of comprehensie value (based on earnings forecasts by analysts) to market value. ***, **, * signifies
significance levels of 0.001, 0.01, and 0.05 respectively, for the t-test. The number of observations for each portfolio is in parentheses.

45

**

Table 10: Future Stock Returns of the B/M - CAF/M Portfolios (continued)
Panel B: 24-Month-Ahead Portfolio Return
Comprehensive-to-Market (CAF/M)

Book-to-Market

CAF/M

Q1
Q2
(Low CAF/M)

Q3

Q4

Q5
(High CAF/M)

All Firms

Q1 (Low B/M)

0.271
(1297)

0.275
(1349)

0.353
(974)

0.354
(552)

0.471
(262)

0.312
(4434)

0.200

**

Q2

0.234
(903)

0.295
(999)

0.374
(1130)

0.344
(931)

0.469
(472)

0.331
(4435)

0.235

***

Q3

0.275
(860)

0.248
(772)

0.289
(961)

0.396
(1113)

0.447
(729)

0.332
(4435)

0.172

***

Q4

0.360
(773)

0.289
(646)

0.314
(812)

0.356
(977)

0.439
(1227)

0.362
(4435)

0.079

Q5 (High B/M)

0.346
(601)

0.374
(669)

0.414
(558)

0.400
(862)

0.476
(1744)

0.420
(4434)

0.131

***

All Firms

0.289
(4434)

0.292
(4435)

0.345
(4435)

0.372
(4435)

0.460
(4434)

0.352
(22173)

0.074

0.100
**

0.061

0.045

0.005

B/M Q5 - Q1
Difference

Q5 - Q1
Difference

Portfolios are formed at the end of the third month after the fiscal-year end and held for the next 36 months. B/M is the book-to-market
ratio and CAF/M is the ratio of comprehensie value (based on earnings forecasts by analysts) to market value. ***, **, * signifies
significance levels of 0.001, 0.01, and 0.05 respectively, for the t-test. The number of observations for each portfolio is in parentheses.

46

Table 10: Future Stock Returns of the B/M - CAF/M Portfolios (continued)
Panel C: 36-Month-Ahead Portfolio Return
CAF/M

Comprehensive-to-Market (CAF/M)

Book-to-Market

Q1
Q2
(Low CAF/M)

Q3

Q4

Q5
(High CAF/M)

All Firms

Q1 (Low B/M)

0.433
(1297)

0.467
(1349)

0.582
(974)

0.573
(552)

0.823
(262)

0.516
(4434)

0.390

***

Q2

0.422
(903)

0.437
(999)

0.565
(1130)

0.511
(931)

0.711
(472)

0.511
(4435)

0.289

Q3

0.386
(860)

0.391
(772)

0.427
(961)

0.613
(1113)

0.783
(729)

0.518
(4435)

0.396

***

Q4

0.558
(773)

0.430
(646)

0.509
(812)

0.547
(977)

0.708
(1227)

0.569
(4435)

0.149

**

Q5 (High B/M)

0.558
(601)

0.572
(669)

0.597
(558)

0.589
(862)

0.684
(1744)

0.621
(4434)

0.125

All Firms

0.460
(4434)

0.457
(4435)

0.533
(4435)

0.567
(4435)

0.718
(4434)

0.547
(22173)

0.126

0.105
*

0.015

0.016

-0.139

B/M Q5 - Q1
Difference

Q5 - Q1
Difference

Portfolios are formed at the end of the third month after the fiscal-year end and held for the next 36 months. B/M is the book-to-market
ratio and CAF/M is the ratio of comprehensie value (based on earnings forecasts by analysts) to market value. ***, **, * signifies
significance levels of 0.001, 0.01, and 0.05 respectively, for the t-test. The number of observations for each portfolio is in parentheses.

47

Table 11: Future Stock Returns of the B/M - CSF/M Portfolios


Panel A: 12-Month-Ahead Portfolio Return
Comprehensive-to-Market (CSF/M)

Book-to-Market

CSF/M

Q1
Q2
(Low CSF/M)

Q3

Q4

Q5
(High CSF/M)

All Firms

Q1 (Low B/M)

0.105
(1387)

0.136
(1451)

0.166
(852)

0.163
(489)

0.224
(202)

0.139
(4381)

0.119

***

Q2

0.099
(860)

0.120
(1081)

0.160
(1176)

0.170
(854)

0.201
(411)

0.144
(4382)

0.102

***

Q3

0.135
(764)

0.124
(803)

0.131
(1033)

0.171
(1091)

0.205
(690)

0.152
(4381)

0.070

***

Q4

0.152
(659)

0.137
(568)

0.145
(870)

0.167
(1073)

0.175
(1212)

0.159
(4382)

0.023

Q5 (High B/M)

0.186
(711)

0.162
(479)

0.174
(450)

0.176
(875)

0.221
(1866)

0.195
(4381)

0.035

All Firms

0.129
(4381)

0.133
(4382)

0.153
(4381)

0.170
(4382)

0.204
(4381)

0.158
(21907)

0.081
***

0.026

0.008

0.013

-0.003

B/M Q5 - Q1
Difference

Q5 - Q1
Difference

Portfolios are formed at the end of the third month after the fiscal-year end and held for the next 36 months. B/M is the book-to-market
ratio and CSF/M is the ratio of comprehensie value (based on a sales-growth model) to market value. ***, **, * signifies significance
levels of 0.001, 0.01, and 0.05 respectively, for the t-test. The number of observations for each portfolio is in parentheses.

48

Table 11: Future Stock Returns of the B/M - CSF/M Portfolios (continued)
Panel B: 24-Month-Ahead Portfolio Return
Comprehensive-to-Market (CSF/M)

Book-to-Market

CSF/M

Q1
Q2
(Low CSF/M)

Q3

Q4

Q5
(High CSF/M)

All Firms

Q1 (Low B/M)

0.238
(1387)

0.313
(1451)

0.369
(852)

0.365
(489)

0.434
(202)

0.311
(4381)

0.196

***

Q2

0.241
(860)

0.266
(1081)

0.372
(1176)

0.376
(854)

0.458
(411)

0.329
(4382)

0.217

***

Q3

0.292
(764)

0.266
(803)

0.277
(1033)

0.384
(1091)

0.467
(690)

0.334
(4381)

0.175

***

Q4

0.376
(659)

0.323
(568)

0.305
(870)

0.364
(1073)

0.420
(1212)

0.364
(4382)

0.044

Q5 (High B/M)

0.368
(711)

0.388
(479)

0.388
(450)

0.369
(875)

0.479
(1866)

0.420
(4381)

0.111

All Firms

0.289
(4381)

0.302
(4382)

0.337
(4381)

0.373
(4382)

0.457
(4381)

0.352
(21907)

0.130
***

0.075

0.019

0.004

0.045

B/M Q5 - Q1
Difference

Q5 - Q1
Difference

Portfolios are formed at the end of the third month after the fiscal-year end and held for the next 36 months. B/M is the book-to-market
ratio and CSF/M is the ratio of comprehensie value (based on a sales-growth model) to market value. ***, **, * signifies significance
levels of 0.001, 0.01, and 0.05 respectively, for the t-test. The number of observations for each portfolio is in parentheses.

49

***

Table 11: Future Stock Returns of the B/M - CSF/M Portfolios (continued)
Panel C: 36-Month-Ahead Portfolio Return
Comprehensive-to-Market (CSF/M)

Book-to-Market

CSF/M

Q1
Q2
(Low CSF/M)

Q3

Q4

Q5
(High CSF/M)

All Firms

Q5 - Q1
Difference

Q1 (Low B/M)

0.415
(1387)

0.529
(1451)

0.596
(852)

0.554
(489)

0.714
(202)

0.517
(4381)

0.299

***

Q2

0.425
(860)

0.410
(1081)

0.539
(1176)

0.602
(854)

0.681
(411)

0.511
(4382)

0.256

Q3

0.393
(764)

0.420
(803)

0.444
(1033)

0.594
(1091)

0.760
(690)

0.518
(4381)

0.367

***

Q4

0.599
(659)

0.489
(568)

0.459
(870)

0.572
(1073)

0.682
(1212)

0.573
(4382)

0.083

Q5 (High B/M)

0.563
(711)

0.645
(479)

0.544
(450)

0.571
(875)

0.674
(1866)

0.619
(4381)

0.111

All Firms

0.465
(4381)

0.487
(4382)

0.512
(4381)

0.581
(4382)

0.692
(4381)

0.547
(21907)

Q5 - Q1

0.148
**

0.116

-0.052

0.017

-0.040

Portfolios are formed at the end of the third month after the fiscal-year end and held for the next 36 months. B/M is the book-to-market
ratio and CSF/M is the ratio of comprehensie value (based on a sales-growth model) to market value. ***, **, * signifies significance
levels of 0.001, 0.01, and 0.05 respectively, for the t-test. The number of observations for each portfolio is in parentheses.

50

Table 12: Risk-Adjusted Returns for Porfolios formed by Comprehensive-value-to-market


Panel A. Excess returns for portfolios formed by CAF/M

Comprehensive-value-to-market (CAF/M)
Q2
Q3

Future Years

Q1
(Low CAF/M)

Q4
(High CAF/M)

Q4 - Q1
Difference

Year 1

0.019

0.165 ***

0.225 ***

0.236 **

0.217 *

Year 2

0.031

0.143 **

0.161 **

0.278 ***

0.247 **

Year 3

0.075

0.116 *

0.306 ***

0.344 ***

0.269 **

Q4
(High CSF/M)

Q4 - Q1
Difference

Panel B. Excess returns for portfolios formed by CSF/M

Comprehensive-value-to-market (CSF/M)
Q2
Q3

Future Years

Q1
(Low CSF/M)

Year 1

0.006

0.160 ***

0.225 ***

0.295 ***

0.289 **

Year 2

0.141 *

0.079

0.217 ***

0.178

0.036

Year 3

0.056

0.101

0.288 ***

0.293 ***

0.237 *

Percent monthly excess return.

Excess (risk-adjusted) returns are calcualted using the four-factor model for quartile portfolios formed on the
basis of the ratio of comprehensive value to market value.

51