The same R&D number means opposite things depending on whether the stock has just won or lost.
Most people read R&D spending as one signal. Maletic shows it's two: the level of R&D and the change in R&D interact with past returns in opposite directions. High R&D pays off after a down year; rising R&D pays off after an up year. The combination of past performance and R&D behavior is what carries the signal.
Section 1 · The question
Does R&D spending predict future stock returns?
Earlier work (Chan, Lakonishok & Sougiannis 2001) showed that firms with a high R&D-to-market-value ratio (RDM) earn higher future returns. But RDM has a problem: its denominator is market value, which itself reflects past returns. So you can't tell whether RDM is picking up "R&D intensity" or just "stocks that have fallen recently."
Maletic untangles the two. He asks two cleaner questions:
- Does the level of R&D (R&D-to-assets, RDA) predict returns? And does it interact with past performance?
- Does the change in R&D (yearly growth, ΔR&D) predict returns? And does it interact with past performance?
The answers turn out to be very different — and that's the point of the paper.
Section 2 · The result in one picture
Two stories, opposite signs
High R&D + bad year → outperform
Why: A firm that has just performed badly but refuses to cut R&D is signaling management confidence the market is missing. The market over-reacts to the bad year, mispricing kicks in, and the stock catches up later.
Rising R&D + good year → outperform
Why: Increasing R&D is only a credible bullish signal when management has already proven they can pick winners. A bad-performing firm that suddenly ramps R&D is not rewarded — only firms with a positive track record are.
Same R&D, opposite interpretations. The cross-product with past return flips the sign.
Section 3 · The four R&D measures
What each ratio is actually capturing
R&D-to-Assets
R&D / Total AssetsA clean level measure. Denominator (assets) doesn't move with the stock price, so this isolates R&D intensity from past performance.
R&D-to-Market Value
R&D / Market CapMixes R&D intensity with past returns (market cap reflects price). Strong predictor — but the source of its power is unclear.
R&D-to-Gross-Profits
R&D / (Revenue − COGS)R&D intensity scaled by raw profitability. In Maletic's regressions, this one has no predictive power on its own.
Yearly R&D Growth
(R&D_t − R&D_t−12) / R&D_t−12A change measure. Captures whether the firm is ramping or cutting R&D — a behavioral signal, not a level.
Note the decomposition: Gross Profitability (GPA) = RDA / RDGP. The control variable GPA already contains the level measure, so the regressions cleanly separate "raw profitability" from "R&D intensity."
Section 4 · The method
Fama–MacBeth cross-sectional regressions
All independent variables winsorized at 1% / 99% to suppress extreme values.
Section 5 · The key numbers
Slope coefficients from Table 3
| Predictor | Slope | t-stat | Sig? | What it means |
|---|---|---|---|---|
| RDA × r−2,−12 | −0.0499 | −2.37 | YES | High R&D level pays off more after bad past returns. The minus sign confirms the interaction. |
| ΔR&D × r−2,−12 | +0.0094 | +4.42 | YES | Rising R&D pays off more after good past returns. Opposite sign to the level interaction. |
| ΔR&D (alone) | −0.0024 | −2.61 | YES | Without conditioning on past returns, increasing R&D hurts on average — only winners are rewarded for ramping. |
| RDM | +0.0021 | +2.49 | YES | R&D-to-market-value still predicts higher returns even after the interactions are added. Anomaly survives. |
| RDA (alone) | ≈ insignif. | +1.20 | NO | Once you control for RDM, the standalone level loses its bite — most action is in the interaction term. |
Both interaction signs are robust to weighted least squares (weighting by firm size). Coefficients shift only marginally.
Section 6 · What the paper failed to show
The R&D-to-market-value anomaly survives
A natural hypothesis (proposed by Chan et al. 2001) is that the RDM premium is really just the "high R&D + bad past returns" story repackaged — because past returns sit in the denominator of RDM. If that were true, adding the RDA × past-return interaction should soak up RDM's predictive power.
It doesn't. RDM's slope stays at +0.0021 with t-stat +2.50, even with everything else in the model. Whatever drives the R&D-to-market-value premium is not the past-return interaction — it's something else, still unexplained.
Section 7 · Bottom line
Three things to remember
Past returns flip the meaning of R&D
Don't treat R&D-to-assets as a single number. The combination with past 1-year return is the actual signal — and the combination has opposite sign for levels vs. changes.
The market is sluggish at updating views on past losers
Firms that perform poorly but refuse to cut R&D are systematically under-priced. Their continued spending is a credible bullish signal the market discounts too heavily.
RDM still hides a separate anomaly
After controlling for the level/change interactions with past returns, R&D-to-market-value still predicts higher future returns. There is at least one more story in there waiting to be explained.
Reference
Source paper
Working paper, Tilburg University Finance Department / Bank of Slovenia Research Department.
SSRN ID 3178186 — version 26 September 2019.
Paper is in the working-paper stage in the version I read; numbers above are from Maletic's Table 3, which uses Newey–West standard errors with lag 12 on Fama–MacBeth (1973) cross-sectional regressions.