Mandatory R&D expensing makes the stock market look more expensive because it forces companies to record research as an immediate cost. That lowers reported earnings and book value while stock prices still reflect expected future sales, so P/E and P/B ratios rise.
R&D means spending to create new products, processes, and software. Expensing means counting that spending at once rather than as a lasting asset. When research budgets grow each year, profit looks smaller than the lasting value created.
Table of Contents
- How smaller earnings raise price multiples
- Why tax rules differ from company accounts
- Why the effect hits the whole market
- What to check before calling stocks expensive
How smaller earnings raise price multiples
Expensing depresses reported earnings and book value when R&D is growing, which mathematically raises P/E and P/B ratios. P/E divides share price by earnings. P/B divides share price by book value.
NYU Stern describes this drag in its valuation slides. The slides show an adjustment that adds back R&D and spreads it over about 2-10 years. For growers, the change raises operating income and capital. A firm with flat research looks little different after adjustment.
Why tax rules differ from company accounts
Under U.S. GAAP ASC 730, firms must generally charge research and development to expense when incurred. The reason is uncertainty about future benefits. The IRS FAQs note a narrow exception for certain software costs after technological feasibility is established. Bloomberg Tax explains the tax shift in its R&D tax explainer. The 2017 Tax Cuts and Jobs Act ended immediate deduction under Section 174 for tax years starting after Dec.
31, 2021. Firms had to capitalize domestic research over 5 years and foreign research over 15 years, including software development. The One Big Beautiful Bill Act signed July 4, 2025 created new Section 174A. It permanently restores immediate expensing for domestic research for years beginning after Dec. 31, 2024. Foreign research remains on 15-year amortization.
Why the effect hits the whole market
NSF NCSES reports scale in report NSF 26-314. U.S. R&D totaled $937 billion in 2023 and an estimated $993 billion in 2024. Businesses performed $722 billion in 2023, concentrated in listed technology and life-science firms.
The Bureau of Economic Analysis treats business, government and nonprofit R&D as fixed investment in GDP. It made that change in its July 31, 2013 comprehensive revision, not as current expense. An Institutional Investor report on professors Baruch Lev and Anup Srivastava reaches a different verdict for company accounts. They found wholesale expensing since the late 1980s distorted earnings and book values and weakened value signals based on low P/E or P/B.
What to check before calling stocks expensive
Capitalization requires judgment about useful life, and not all R&D pays off. Investopedia notes investors should compare R&D-adjusted earnings that spread costs before judging the market expensive.
The warning matters most for R&D-heavy indexes. Use adjusted earnings for technology and life-science screens. Treat a high headline P/E as a prompt to adjust, not proof of overpricing.
- Compare headline P/E with R&D-adjusted earnings that spread research costs.
- Split R&D-heavy sectors from low-R&D stocks before judging value.
- Allow for failed projects when you pick an amortization life.
For the whole study explained, with every figure checked against the September 18, 2026 version of the paper, read The CAPE That Cried Wolf: What CAPE-H Says About Stock Valuations.