Gavekal Capital: Innovation Boom, R&D Spillovers and Stock Performance

Tuesday, March 17, 2015

Innovation Boom, R&D Spillovers and Stock Performance

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