Intangibles Investment and Asset Quality

Treating expenditures that create intangible assets as investments yields a profitability measure that more accurately reflects asset quality. Firms with higher intangibles-adjusted profitability generate higher cash flows over longer periods, and their returns exhibit both lower downside risk and lower co-tail exposure to market shocks. A long-short factor portfolio constructed from this measure delivers a 2.9% to 6.6% Fama-French alpha, driven by superior stock selection on the long side and effective market timing on the short side. The short side captures mispricing from investor overoptimism about the prospects of low-quality firms.