Patents as an innovative source of alpha

By Oliver Murschall

Smart ideas create a competitive advantage and added value for enterprises. The challenge in portfolio management is to determine the value of such innovations and to apply this to stock selection. The reported value of patents offers little help in this regard, which is why alternative data are being used. Based on univariate and multivariate analyses, our organisation incorporates patent information into our alpha and risk models. The analyses show that investment strategies that buy companies with high patent values and sell those with low patent values have the potential to generate excess returns.

We use alternative data from a provider that specialises in carrying out patent valuations for companies, due to the fact that the balance sheet value of patents is not very helpful here. This database for traded patents is based on transaction information gained from mergers and acquisitions, auctions or manual valuations. The data set is trained using a learning process in order to identify indicators which are relevant to valuation – including market-based, legal or technical details of patents. To assess individual patents, they are compared to traded patents with similar characteristics.

At present, the global data set contains usable data for around 10,000 enterprises covering more than 86% of the MSCI World market capitalisation. The five companies with the most valuable patent portfolios account for an aggregate value of more than EUR 267 billion.

Aggregated by country, Japan and the US account for more than 70% of global patent values, as shown in Figure 1; these countries are the major innovators in terms of patent value by a large margin, followed by South Korea, Germany and France. Taking a sector view, the technology sector comes first – as one would expect – with just under 40% of global patent values.

PATENT VALUE AFFECTS THE OVERALL COMPANY VALUATION

Two aspects of patent portfolios are relevant for enterprises: the first one is the value of the patent portfolio, the

Based on univariate and multivariate analyses, we incorporate patent value and quality in our alpha and risk models in the form of factor composites.

second is the quality of the patents. The first aspect, the value of the patent portfolio, impacts the enterprise value. The more valuable the patents, the higher the valuation. Even though carrying amounts provide an indication of the value of patents, under US Generally Accepted Accounting Principles these must be recognised at cost – meaning that only purchased patents are reflected here. Under IFRS, patents may be carried at their development costs – which, however, frequently provide little information concerning their economic potential.

Figure 1: Global patent values, by country and by sector

Sources: MSCI, IPR Strategies, Quoniam (own calculations)

competitors – differs by industry. When looking at the ratio of an enterprise’s patent value to its assets, it is obvious that the power to innovate has enormous importance for companies in the healthcare and technology sectors in particular. For businesses in the real estate and financial services sectors, or for utilities, innovative power is less relevant.

HIGH-QUALITY PATENTS SECURE FUTURE EARNINGS

The second aspect, the quality of patents, has an immediate impact upon the quality of the enterprise: highquality patents secure a company’s future earnings during the term of the patent right and beyond. Ultimately, the power to innovate sustainably secures an enterprise’s continued existence on the market – with market potential as well as legal and technical aspects playing a role in this context.

PATENT INFORMATION DELIVERS SIGNIFICANT ADDED VALUE IN SELECTING SHARES

Based on univariate and multivariate analyses, our organisation opted in

Figure 2: Indexed performance data of long/short strategies

2018 to incorporate the aspects mentioned in its alpha and risk models in the form of factor composites. Figure 2 shows indexed performance data of a long/short strategy between a top and a bottom quintile. Portfolios were structured on the basis of parameters for the factors of ‘patent valuation’ and ‘patent quality’ in a European investment universe.

The strategy using the patent valuation factor generated an average annual return of 4.55% during the period from December 2010 to May 2019. The same strategy using the quality factor generated an average annual return of 4.89% since 2010.

The analyses have shown that using patent information generates significant added value for share selection. In this connection, the low correlation of the factors shown to the existing alpha signal is worth highlighting. This means that the factors of patent valuation and patent quality comprise additional information which is not included in the existing alpha factors in this form. «

This article was written by Dr. Oliver Murschall, Executive Director, Research at Quoniam.