Japanese patent index and stock performance

In the global economy, high technology serves as a source of competitive advantage for Japanese companies. In Japan, there is a patent value indicator which is unique among other patent value indicators developed in the U.S. The uniqueness lies in its focus on measuring the exclusivity and technological competitiveness of each patent using data based on the number of actions taken by third parties against the patent. The construction of such a patent value metric became possible thanks to the Japanese Government’s active disclosure of information on patent attacks. This paper is our first attempt to study the relationship between technological competence and firm performance using this technology indicator. In particular, we demonstrate how this technology indicator may be used to forecast company stock performance. We construct long/short strategies based on (1) the patent indicator, (2) R&D expenditure and (3) a combination of the two. The third strategy was the best performer. Combining R&D expenditure, which is readily available in financial statements, with the patent indicator enhanced portfolio expected return and reduced risk considerably. The best-performing strategy generated an annual mean return of 11.50%, standard deviation of 9.25%, and a Sharpe ratio of 1.23. The return is not attributable to the Fama–French three factors. Technology indicators should not work in some industry groups, hence, the result is even more striking given that the portfolio was constructed with a universe of stocks covering all industry groups except financials.