R&D, Past Returns & Stock Returns

Earlier work found that a high R&D-to-market-value ratio predicts higher future returns, but that ratio has market value in the denominator, so it cannot separate R&D intensity from “the stock has fallen recently.” Maletic splits R&D into two distinct signals — the level (R&D scaled by assets) and the change (year-on-year growth) — and interacts each with past one-year return.

The two interactions carry opposite signs. A high R&D level pays off after a bad year: a firm that has just performed poorly and still refuses to cut research is making a credible statement the market discounts too heavily. A rising R&D budget pays off after a good year: ramping spend is only believed when management has already shown it can pick winners.

The practical reading is that R&D is not one number. Past performance flips its meaning, and the combination — not either component alone — is what predicts. After controlling for both interactions, the older R&D-to-market-value anomaly still survives, so at least one further story remains unexplained.