Hall (2001a) argues that the value of intangible assets can be inferred from firms’stock market value and the value of tangible assets, which suggests rational valuation in the market. This paper investigates the relationship between firms’future stock returns and their inferred intangibles and indirectly tests Hall’shypothesisby using various trading strategies. It is found that the inferred intangibles have predictive power for stock returns, which might be because of mean-revertingmisvaluation by the stock market; and the way the inferred intangibles predict stock returns is consistent with the three-factor model of Famaand French (1992). However, I find that the predictive power of inferred intangi- blesisconsistent with market inefficiency, rather than a rational premium for distress risk related to the book-to-market equity ratio. Thus the intangible assets hypothesis of Hall does not hold and the discrepancy between market equity and book equity suggests mar- ketinefficiency. JEL Classification Number: G12 Keywords: intangible assets, stock returns, stock market overreaction, mean reversion of stock prices, book-to-market-equity ratio. 1. Introduction Hall (2001a) proposes that the rational stock market valuation of intangible assets—assets that are not directly measurable such as human capital, trademarks, research and development, customer relationships, goodwill, etc. —explains the observed discrepancy between the stock market value of the firm and the reproduction cost1 of the firm’stangi- bleassets. This sounds intuitively plausible because intangible assets generate cash flows and thus affect a firm’sfutureearning power. Also, since the value of tangible assets is typically justafractionof the market value, presumably the rest of the value comes from intangible assets…

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