The effect of R & D on future returns and earnings forecasts

Prior studies attribute the future excess return patterns of R&D firms to either compensation for increased risk from R&D or to mispricing by investors. We suggest a third explanation for the future excess returns of R&D firms. We show that neither the level of R&D investment nor the change in R&D investment explains future returns. Rather, the positive future returns prior studies attribute to R&D investment is actually due the component of the R&D firm's realized return that is unrelated to R&D investment, but present in R&D firms. Our results suggest that the excess returns of R&D firms are part of the larger value/growth anomaly. In addition, we show that while future earnings are positively associated with current R&D, the earnings forecasts of investors and analysts are not affected by a firm's R&D investment policy