By |Published On: December 9th, 2021|Categories: Intangibles, Research Insights, Factor Investing, Larry Swedroe|

Despite the fact that a company’s internally generated intangible investments create future value, under current U.S. generally accepted accounting principles, internally developed intangibles are not included in reported assets. While research and development is an important intangible asset, so too is branding. Omission of an increasingly important class of assets reduces the usefulness and relevance of financial statement analysis that uses book value.  

Kai Wu, chief investment officer of Sparkline Capital, has done some very interesting and innovative work on the role of intangibles, including the papers “Investing in the Intangible Economy” and “Measuring Culture.” In his most recent paper, “Brand in the Influencer Era,” he noted: “Social media is democratizing consumer influence, empowering ordinary individuals to shape brand perception.” With that in mind, he identified brands with strong positioning using social media discourse and network structure. Wu then built a factor which he appropriately named “strong brand factor” that buys U.S. consumer stocks (trading on NYSE and Nasdaq) with the strongest brands and shorts those with the weakest, neutralizing industry exposure (i.e., zero net exposure to each industry) to ensure brands are compared only to their competitors. When I spoke with the author about his study, he told me that from January 1, 2010, through October 15, 2021, the strategy (in backtest) produced an annual excess return of 1.9 percent (t-stat = 2.35) before transaction and financing costs, and did so with a high degree of persistence; turnover was high, at 100 percent.

Wu then used Twitter to build a “brand social network,” explaining that if two brands have a lot of common followers, he drew a link between them. He noted:

“Many brand pairs are intuitive complements. Hikers buy both PowerBars and CamelBaks; homeowners use Terminix and Scotts lawn care.”

Having built a brand social network, he used it to backtest a network momentum strategy. He assigned each brand a score based on the 12-month rolling return of the brands to which it is connected. When a brandʼs friends did well, the strategy buys; and when they did poorly, the strategy sells. He noted that because research has shown that stock returns are higher after industry peers outperform (i.e., industry momentum), his strategy was industry neutral. 

Wu also told me that over the period 2011-October 15, 2021, his brand network momentum strategy delivered an annual return of 3.4 percent (t-stat = 2.18) before considering transaction and financing costs. Again, turnover was high, at 200 percent. “Moreover, it had a blowout year in 2020, when the fast-moving Covid pandemic disrupted both supply chains and financial market price discovery. In times of crisis, having a detailed graph of the links between firms can be invaluable.” From 2011 through 2019, the strategy returned 1.8 percent per annum (excluding transaction and financing costs). 

Wu next examined the issue of “sustainable brands,” one of the hottest current marketing trends. He noted: “Surveys indicate that rising generations are more likely to buy from brands that reflect their values, and firms are rushing to capitalize on this growing demand.” To address this, he focused on two facets of sustainability: environmentalism and equality.

Wu concluded:

“Over the past decade, our strong brand strategy has produced consistent outperformance. Strong brands are a deep moat that affords firms greater pricing power, sales volume, and customer loyalty. Furthermore, the robust historical performance of the factor implies that the market does not fully recognize the value of this powerful but intangible asset.” 

Wu’s analysis supports the view that the market may be undervaluing branding—while companies invest billions to build brand equity, this intangible asset does not appear on balance sheets. Wu did note that the accounting profession’s decision to not capitalize brand investment is not completely without merit because efforts to build brand equity can produce a wide range of potential outcomes. However, he noted that:

“in the influencer era, the nexus of consumer power has migrated online. It has moved to the very domain that is the most fertile ground for NLP [natural language processing] and other modern data analysis techniques. With the exponential growth in user-generated data, investors are better positioned than ever to quantify this important intangible asset.”

Investor Takeaway

Wu’s work highlights the importance of the value of intangible assets and the ability of artificial intelligence tools such as NLP to help quantify their worth. A few words of caution are noted. First, Wu’s analysis covered a period of only just over a decade, from 1/1/2010 to 10/15/2021. Second, this period was one in which value stocks severely lagged the market. This raises the possibility that this brand strategy tends to buy growthy stocks. If that is the case, it might lag notably when value stocks outperform. Third, the analysis did not consider transaction or financing costs, and the strategy does involve high turnover. With that said, given the increasingly important role that intangibles play, we are likely to see an increase in research into the value of intangible assets, including branding, research and development, and employees (including corporate culture). Stay tuned.

Important Disclosure:

For informational and educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. The analysis contained in this article is based upon third party information available at the time which may become outdated or otherwise superseded at any time without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party websites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them. The opinions expressed by featured authors are their own and may not accurately reflect those of the Buckingham Strategic Wealth®, Buckingham Strategic Partners® (collectively Buckingham Wealth Partners). Neither the Securities and Exchange Commision (SEC) nor any other federal or state agency have approved, determined that accuracy or adequacy of this article. LSR-21-181

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About the Author: Larry Swedroe

Larry Swedroe
As Chief Research Officer for Buckingham Strategic Wealth and Buckingham Strategic Partners, Larry Swedroe spends his time, talent and energy educating investors on the benefits of evidence-based investing with enthusiasm few can match. Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has since authored seven more books: “What Wall Street Doesn’t Want You to Know” (2001), “Rational Investing in Irrational Times” (2002), “The Successful Investor Today” (2003), “Wise Investing Made Simple” (2007), “Wise Investing Made Simpler” (2010), “The Quest for Alpha” (2011) and “Think, Act, and Invest Like Warren Buffett” (2012). He has also co-authored eight books about investing. His latest work, “Your Complete Guide to a Successful and Secure Retirement was co-authored with Kevin Grogan and published in January 2019. In his role as chief research officer and as a member of Buckingham’s Investment Policy Committee, Larry, who joined the firm in 1996, regularly reviews the findings published in dozens of peer-reviewed financial journals, evaluates the outcomes and uses the result to inform the organization’s formal investment strategy recommendations. He has had his own articles published in the Journal of Accountancy, Journal of Investing, AAII Journal, Personal Financial Planning Monthly, Journal of Indexing, and The Journal of Portfolio Management. Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television shows airing on NBC, CNBC, CNN, and Bloomberg Personal Finance. Larry is a prolific writer and contributes regularly to multiple outlets, including Advisor Perspective, Evidence Based Investing, and Alpha Architect. Before joining Buckingham Wealth Partners, Larry was vice chairman of Prudential Home Mortgage. He has held positions at Citicorp as senior vice president and regional treasurer, responsible for treasury, foreign exchange and investment banking activities, including risk management strategies. Larry holds an MBA in finance and investment from New York University and a bachelor’s degree in finance from Baruch College in New York.

Important Disclosures

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice.  Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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