Yes, it is a correct statement that CSC does not have the quant chops to do our own work in this space (Well, Partner Eugene Robin does, but he has higher and better use elsewhere), but we read widely. Smithers has correctly been a noted “downer” on equities and their valuation for..decades?….but he remains a thoughtful researcher and writer. The premise here is that people justify tech/growth valuation on the concept that intellectual property spend is not properly captured and compared to spending on tangible things like factories and thus when you apples to apples them via some accounting adjustments, tech earnings are higher than you think and thus valuation is lower. This piece takes a shot at that.
It’s a long read embedded below, but I’ve pasted the ending summary from page 36 if you just want a quick read.
Summary
Claims that investment in IP has been understated due to an excessively rapid rate of depreciation are clearly incompatible with the data on equity returns.
A reduction rather than an increase in profits is needed to bring them into line with these data on returns and this raises the issue of whether the inclusion of IP spending as investment has been a sensible change in the measurement of GDP and other national income metrics.
My own view is that the change has been a mistake for both practical and theoretical reasons. The practical case against is that the data on IP spending are suspect and its subsequent value and thus depreciation unmeasurable. The theory for its inclusion is based on the improbable assumption that all IP spending is made to increase future output or profits. Those who make this assumption agree that advertising expenditure should therefore be classed as investment. Without doubting the value of advertising, I think that many economists would agree with me that it belongs in a separate category from investment. I also point out that the fact that, while an individual company can add to its value by successful spending on IP, including that on R&D and advertising, this does not mean that the value of the business sector’s capital has risen. One company’s successful R&D reduces the value of other companies’ net worth and one firm’s advertising reduces the value of another’s spending.
It would be useful to have good data on spending on R&D and other forms of IP, but their inclusion as part of investment seems to me to be a category error. It has led to understating the fall in investment, which has occurred since 2000 in the UK and the USA, and contributed to the mistaken belief that the labour share of output is historically low.
Original article posted at World Economics Journal.
