Joff Wild over at IAM blog has a piece on OceanTomo’s new report on intangible valuation. According to OceanTomo, “In 2009, the implied intangible asset value of the S&P 500 reached 81%, an all-time high for the years covered by the firm’s research, which extends back to 1975.” As Joff points out in his piece, some of these claims of 70% plus intangible valuation have been challenged.
OceanTomo did provide Joff with the following explanation of their methodology:
INTANGIBLE BOOK VALUE METHODOLOGY
Intangible book value is calculated by subtracting the tangible book value from the market capitalization of a given company or index. In practice, companies report tangible book value per share, number of shares outstanding, and market capitalization. Therefore, intangible book value can be calculated by subtracting the market capitalization from the tangible book value per share multiplied by the number of shares outstanding.
It is expedient to do the calculation on a per share basis, as we have done here, and simply subtract the tangible book value per share from the market price. There are modest discrepancies between the two numbers due to differences in setting shares outstanding on a company by company basis. However, the discrepancy is rarely a few percentage points which are within the error needed for most purposes.
While I appreciate the attempts by OceanTomo to put a value on intangible assets, I remain concerned and skeptical of this methodology. The difference between tangible book value and market capitalization certainly contains the intangible asset value. But it also contains a lot more. For one thing, it including the difference between the market’s valuation of the physical and financial capital and the official book value of those assets (note the whole mark-to-market controversy in accounting). It also contains what some call the market froth — or the irrational exuberance. That fact works both ways — inflating the market value of the stock and deflating it as well. When the stock market tumbled recently, billions of intangible value did not simply disappear – did it?
Thus I am skeptical of using market capitalization to tell us anything of intangible company value – except for where the psychology of the market may be. For example, in 2008 — according to the Federal Reserve Board’s Flow of Funds Account — the total net worth of US non-farm, non-financial corporations was $14.2958 trillion — tangible assets of $14.2249 trillion (real estate, equipment and software, inventories — at market value or replacement cost), financial assets of $13.5006 trillion, and $13.4297 trillion in liabilities. The market value of equities outstanding for these non-farm, non-financial corporations was only $10.0364 trillion — for a equities/net worth ratio of 70.2% Does this mean that intangibles had a net worth of negative $4.2 trillion?
I would rather refer you to the work of Charles Hulten and colleagues who looks at expenditures on intangibles as investments and then modifies the balance sheets value accordingly. By this measure, intangibles are still important:
For pharmaceutical firms, intangible assets account for 39% of total assets for German firms and 54% for American firms. R&D capital accounts for 24% of total assets in German pharmaceutical firms and accounts for 39% of total assets in American pharmaceutical firms. Organizational capital accounts for 15% of total assets in both German and American pharmaceutical firms. For IT firms, intangible assets account for 38% of total assets for German firms and 43% for American firms. R&D capital accounts for 29% of total assets in German IT firms and accounts for 26% of total assets in American IT firms. Organizational capital accounts for 9% of total assets in German IT firms and 17 in American IT firms.
Those strike me as much more plausible numbers. I especially like the industry-specific calculations given the variation among industries in their intangible asset intensity.
So – yes intangibles are a major part of company value. But let’s be careful to not fall into the trap of over-hype. The concept of intangible assets and intellectual capital is already beginning to take root — even in policy debate (i.e. the reference to intellectual capital in the Obama Administration’s manufacturing policy). Let’s make sure we build further understanding of and confidence in intangibles based on solid ground.