23 Jan 2024 3 min read

Value meets vision: the rise of innovation capital

By Jason Lee

In the first instalment of a two-part blog, we chart the increasing importance of intangible assets, and consider the implications for value investors.


Value investing is an age-old idea that was popularised by Benjamin Graham in the 1920s. The concept is very simple: buy securities at bargain prices and profit from selling them at fair value or higher.

There are various ways to assess whether a company might be considered undervalued or overvalued. One long-established approach is the price-to-book (P/B) ratio, where the market value of a company is compared with its accounting book value. A low P/B ratio suggests a company may be undervalued, while a high P/B ratio indicates a potential overvaluation.1

Within factor investing, the value factor aims to capture the principles of value investing in a systematic framework by consistently overweighting securities with low P/B ratios and underweighting those with high ratios, thus systematically exposing investors to undervalued companies.

In the factor investing landscape, conventional measures of valuation such as P/B are metamorphosising to adapt to today’s knowledge-driven economy.

The growing influence of innovation capital

Intangible assets are becoming a key value generator for most companies and industries.

For example, consider the iPhone. Apple* undertook extensive research and development (R&D) to develop features such as the touchscreen and the iOS operating system. It was only after many years that the company was able to launch the iPhone, which revolutionised the smartphone industry and became a crucial driver of the company’s bottom line. Similarly, Amazon’s* AWS cloud business required a huge R&D effort, which over time enabled the company to dominate the market.

In the modern economy, businesses have undergone a gradual structural shift from capital-intensive models to asset-light, service-platform models. This has altered the structure of a company’s assets, with a growing focus on unrecorded intangible investments, particularly in research. Collectively, this is known as ‘innovation capital’ and can be proxied by capitalising past R&D costs that were expensed under GAAP principles.

The chart below shows the rising share of innovation capital as a percentage of total assets.


Likewise, the ratio of R&D expense to total costs (COGS) has virtually doubled over the period, reflecting the rising importance of R&D for long-term competitive advantage.


Innovation capital at the sector level

An analysis of the largest 500 US companies2 highlights the varying impact on the P/B ratio when adjusting for innovation capital. The chart below shows the average P/B ratio by sector, before and after adjustment.

Those industries showing the largest reductions in their valuations, such as healthcare, IT and consumer staples, are known to invest in R&D to generate value over the long term. Making these adjustments therefore results in such sectors appearing more value-oriented than before.

Conversely, sectors such as energy and utilities show very little adjustment, which is unsurprising since these are the most tangible asset-heavy industries.


With the current trends of artificial intelligence, blockchain and climate technology set to continue into 2024 and beyond, we believe companies look likely to continue heavy investment in R&D to remain competitive.

In part two of this blog, we’ll consider the underlying risk premia targeted by value investing and will analyse how including innovation capital in a systematic value factor strategy affects performance.  

*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.

1. Source: Zaher F. Index Fund Management: A practical guide to smart beta, factor investing, and Risk Premia. Basingstoke: Palgrave Macmillan; 2020.

2. Representative universe is based on the S&P 500 Index.

Jason Lee

Quantitative Strategist, Index Solutions

Jason is a Quantitative Strategist in the Index Solutions Group, responsible for the research and development of LGIM’s bespoke systematic index strategies. Jason joined LGIM in June 2021 from the Currency Portfolio Management team at Russell Investments. Prior to that, he worked as an Analyst at Nomura International plc and at Bank of America Merrill Lynch. Jason graduated from the University of Nottingham with a BSc (Hons) degree in Economics and an MSc in Mathematical Trading & Finance from the Bayes Business School (formerly Cass), University of London. He also holds a certification in Sustainable Finance from the University of Cambridge.

Jason Lee