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Firm Innovation Group Performance Persistence

Posted in Fundamental Valuation, Momentum Investing

Do firms that acquire patents in similar technologies persistently perform similarly? In the October 2017 draft of their paper entitled "Technology and Return Predictability", Jiaping Qiu, Jin Wang and Yi Zhou examine monthly performance persistence of stocks grouped by similarity in recent firm patent activity. Specifically, they:

  1. Record the patent activity of each firm by patent class over the most recent three calendar years.
  2. Quantify similarity of this patent activity for each pair of firms.
  3. Segregate firms into innovation groups based on patent activity similarity (top fifth of quantified similarities).
  4. For each month during the next calendar year:
    • Rank stocks into fifths (quintiles) based on average prior-month, similarity-weighted return of their respective groups.
    • Form a hedge portfolio that is long (short) the equal-weighted or value-weighted stocks in the highest (lowest) return quintile.

They focus on gross average monthly return and stock return factor model alphas of the hedge portfolio as evidence of firm innovation group performance persistence. Using firm patent information by technology class during 1968 through 2010, and monthly stock data, quarterly institutional holdings and analyst coverage for a broad sample of U.S. stocks priced greater than $1 during 1968 through 2011, they find that:

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