Underrated Investment Advantage: Company Trademark Filings

Not part of financial reports, brand activity predicts stock returns

Hedge funds and the broader class of institutional investors employ armies of PhDs tasked with creating the next great obscure algorithm that can exploit a market or trading inefficiency for profit.

Research Posted in management sciences reminds that, sometimes, a clever analysis of seemingly prosaic public data is enough to find an investment advantage.

The neglected brand factor

Po-Hsuan Hsu from National Tsing Hua University, Dongmei Li from University of South Carolina, Qin Li from Hong Kong Polytechnic University, Siew Hong Teoh from UCLA Anderson and Kevin Tseng from National University of Taiwan extracted the database of the United States Patent and Trademark Office to study the predictive value of new brands on the valuation of shares of a public company. All approved marks are reported weekly in the official USPTO Gazette.

In the ecosystem of intellectual property protection, trademarks are the less sexy – and therefore the most neglected – cousin of patents. A patent is a claim on innovation, a sacred ingredient of capitalism. A trademark is simply the protection of brand image built around a product or service.

Yet the researchers find that the companies that retire the most marks each year — relative to their total assets — can deliver an intriguing clue: their stock performance, on average, is higher over the next 12 months than the companies that weren’t as active. with new brands.

Researchers are among the first to organize this large volume of brand data which, as it exists, is not in a user-friendly format. (They hope the reconfigured dataset can be useful in the future for researchers and innovation investors.)

Using data from over 300,000 trademark registrations filed with the USPTO from 1976 to 2014, the researchers designed a hedged portfolio that took long positions in the top third of companies that are the most registered trademark filers. assets over a 12-month period and short-circuited the companies whose brands business ranks in the bottom third.

The annualized return of the hedged brand portfolio averages 5.2%. Adjusted for industry performance, the hedged portfolio still managed an annualized return of 3.7%. The brand factor also “predicts significantly higher return on equity and return on assets.”

The authors note that most of the outperformance is due to the long side of the hedging portfolio, suggesting that new brands are a compelling signal of promising innovation that leads to increased sales.

Yet the outperformance advantage fades after the first 12 months. The authors posit that the initial performance advantage is indeed the result of analysts and other investors not reading the brand’s tea leaves.

Hiding in plain sight

US companies are not required to treat intellectual property as a self-valued asset on their balance sheet. Still, a company is likely to provide insight into its patent pool and how that translates into revenue prospects and ultimately earnings potential. (Think: big pharma.) Trademarks? Not really.

And that creates a blind spot for the analysts and investors who rely on them. The researchers find that in their database, the average analyst forecast error was significantly higher among companies that were in the high brand activity tercile compared to companies that were less active in branding. trademark registration.

The researchers note that the level of undervaluation of new brands correlates with the degree of analytical difficulty in valuing a given company. The more complex a company, the greater the R&D budget (there will be successes and failures) and the greater the dispersion of analyst forecasts, which leads to greater undervaluation of new brands.

The authors also drop two intriguing crumbs for prone research. The extent of undervaluation of new brands was greater when a company’s brands began to appear in new USPTO categories (apparently a sign of entry into new areas) and when new brands elicited more opposition from competitors (companies can oppose a trademark application before it is approved by the USPTO).

The authors present their research as evidence that companies should be encouraged/required to provide more brand valuation guidance in their reports. But that would involve the Securities and Exchange Commission providing safe harbor protection.

In the meantime, enterprising investors might regard the research as a kind of crude instruction manual for analyzing the potential upside of mispriced companies in mark-heavy mode.

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