From "Does the Stock Market Underreact to R&D Increases?" by Allan Eberhart, William Maxwell, and Akhtar Siddique,
"We examine a sample of 8,313 cases, between 1951 and 2001, where firms unexpectedly increase their research and development expenditures (R&D) by a significant amount. We find consistent evidence that our sample firms are undervalued following their R&D increases as manifested in the significantly positive long-term stock returns that our sample firms' shareholders experience. We also find consistent evidence that our sample firms have significantly positive long-term abnormal operating performance following their R&D increases. Our findings suggest that R&D increases are beneficial investments, and that the market is slow to recognize the extent of this benefit (consistent with investor underreaction)."It could be investor underreaction, the phenomenon whereby investors are "anchored by salient past events". There is plenty of research showing that investors underreact to all sorts of news: good earnings, bad earnings, share repurchases, financial distress, dividend initiations, stock splits and reverse splits, and so forth.
But there's another hypothesis for an underreaction to research and development expenses, a theory we touched on last week: no one believes in plans. We have people like William Bernstein arguing that the long-run real rate of return on capital is one percent, if you're lucky. This is the indeterminate world idea that Peter Thiel talks about,
"In a determinate world, there are lots of things that people can do. There are thus many things to invest in. You get a high investment rate. In an indeterminate world, the investment rate is much lower. It’s not clear where people should put their money, so they don’t invest. [...] Indeterminacy has reoriented people’s ideas about investing. Whereas before investors actually had ideas, today they focus on managing risk. [...] In an indefinite world, investors will value secret plans at zero. But in a determinate world, robustness of the secret plan is one of the most important metrics. Any company with a good secret plan will always be undervalued in a world where nobody believes in secrets and nobody believes in plans. The ability to execute against long-term secret plan is thus incredibly powerful and important."Underreaction to research and development is perfectly consistent with Thiel's idea. And public markets currently put a huge premium on predictable, non-divertable cash flows and more attractive (lower) multiples on cash flows that are seemingly uncertain.