N°23-107: R&D, Innovation, and the Stock Market

We investigate the relation between inventive input (R&D), inventive output (the economic value of patents, EVP), firm-level profitability and asset growth, and stock returns. Current R&D and EVP forecast future profitability. Neither forecast future asset growth. Factor models motivated by q-theory and the dividend discount model fail to price R&D and EVP correctly, leaving large alphas on the table. But model failure is due to design specifics, not economic underpinnings: using cash-based operating profitability to measure expected profitability resurrects both models. The stock market does not appear to misprice inventive input or output.