More on measuring intangibles using SG&A

In earlier postings I described the work of Michael J. Mauboussin & Dan Callahan of Morgan Stanley (One Job: Expectations and the Role of Intangible Investments) and Luminita Enache & Anup Srivastava (“Should Intangible Investments Be Reported Separately or Commingled with Operating Expenses? New Evidence”) in using a reframing of companies’ reported operating expenses and SG&A (sales, general, and administrative costs) to measure investments in intangibles. That reframing divides operating expenses into R&D, advertising, Maintenance SG&A (expenditures needed to continue normal operations such as office and warehouse rents, customer delivery costs, and sales commissions) and Investment SG&A (spending that seeks to build organizational assets including employee training and customer acquisition costs).

Mauboussin & Callahan’s latest paper (“Market-Expected Return on Investment”) extends their discussion. Most of the paper involves a somewhat technical discussion of the use of the measure of return on investment known as MEROI (market-expected return on investment). For my purposes, I am interested their updates of their earlier calculations on intangible investments to 2020 and the breakdown they provide of intangible intensity by industry.

The updated chart (see below) clearly shows the massive increase in intangible investments over the past 20 years, along with the relatively minor impact of the COVID-19 slowdown. The financial meltdown of Great Recession appears to have had a much larger impact but was followed by a strong recovery.

Note that the data presented here is not exactly comparable with the data presented in the earlier article. Mauboussin & Callahan’s most recent calculations show intangible investment as the sum of Investment SG&A, R&D expenditures and advertising. The chart in the earlier paper showed each of these as separate. Also the chart in the earlier paper showed expenses as a percent of total assets. The newer chart shows total dollar amounts of expenditures.

The data provided on intangible intensity are also of interest – but in keeping with what I, at least, would expect. One concern, however. The intangible intensity calculations are from Duger & Pozharny’s paper (“Equity Investing in the Age of Intangibles”) which uses aggregate SG&A as their measure of intangible assets. I think this is somewhat problematic. As Enache & Srivastava pointed out, some industries, such as consumer goods, apparel, and retail, have higher maintenance costs than others. Thus, industries differ in the amount of SG&A that should be considered an investment in intangibles – which is not done in this case. Dugar & Pozharny argue that since they are presenting a relative ranking and not a value, this omission does not affect the findings.

The Mauboussin & Callahan article also provides some interesting references. One referenced paper that caught my eye is by Michael Ewens, Ryan H. Peters & Sean Wang, “Measuring Intangible Capital with Market Prices.” Ewens, Peters & Wang also use a modified version of SG&A. They estimate that only 27% of SG&A should be considered Investment SG&A (aka organizational capital). But they found a great variation by industry with a high of 40% for healthcare and a low of 19% for consumer goods. They also calculated industry intangible intensity as measured by the stock of intangible assets. Healthcare was again the highest with manufacturing being the lowest. [Not that for all the concern I raised about Duger & Pozhany’s findings, they are in keeping with Ewens, Peters & Wang’s analysis.] [Note also that Duger & Pozhany reference others’ estimates that 30% of SG&A is organizational capital.]

Source: Michael Ewens, Ryan H. Peters, and Sean Wang, “Measuring Intangible Capital with Market Prices,” NBER Working Paper 25960, January 2020

The papers cited above are just a few of the most recent studies using SG&A as a measure of investment in intangibles. There are a number of other papers referenced in the above cited papers. Clearly, academic interest in the topic and technique has been picking up.

Given all this new research, let me repeat what I said in an earlier posting: the SEC should create a “safe-harbor” provision to allow for an alternative reporting of companies’ sales, general, and administrative costs (SG&A). This alternative would refine the current reporting of SG&A to breakout spending on intangibles from more routine spending. Such a “safe-harbor” provision would not replace the current reporting requirements but simply allow companies to report additional information. This could serve as a pilot to determine if mandatory reporting of alternative SG&A data should be required.

As the articles and studies cited above (and many others) show, investments in intangibles are a major part of companies’ financial activities. Reporting on such investments is is long overdue. The tools for such reporting are available. SEC should facilitate their use.

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