The last decade has seen a marked reduction in the performance of systematic, quantitative value strategies, and particularly so for U.S. markets. One critique has been that the growing importance of intangibles, and the failure of the accounting system to record their value on financial statements, renders value measures anchored to current financial statements, such as book value, useless. New research shows how to address this failure.

In their 2020 study, Explaining the Recent Failure of Value Investing, authors Baruch Lev and Anup Srivastava suggested that capitalizing research and development (R&D) expenditures and selling, general and administrative expenses, and amortizing this “asset” over industry-specific schedules yield adjusted, and possibly improved, measures of book equity and earnings. Their empirical analysis suggests an improvement for value strategies using such adjustments. Data vendors (e.g., Credit Suisse, HOLT and New Constructs) are now attempting to correct for multiple limitations embedded in the financial reporting systems.

One way that academics and fund managers have tried to address the problem is to use alternative value metrics such as price-to-earnings (P/E), price-to-cash flow (P/CF) and enterprise value-to-earnings before interest, taxes, depreciation and amortization (EV/EBITDA). Many fund families (such as AQR, BlackRock, Bridgeway and Research Affiliates) use multiple metrics. Another alternative is to add other factors into the definition of the eligible universe. For example, since 2013 Dimensional has included profitability as a screen in their value funds. A third alternative is to add back to book value an estimate of the value of intangibles, such as R&D expenses.