Michael Mauboussin recently released a paper titled – One Job: Expectations and the Role of Intangible Investments in which he discusses the impact of intangibles in company valuation. The paper focuses on three aspects of intangibles – measurement, characteristics, and the implications for investors. Here’s an excerpt from the paper:
Here is the key insight: Understanding the magnitude and return on investment provides an investor with a better understanding of a company’s future earnings. The challenge is that the mix of investment has shifted over time and is today more intangible than tangible. That means the recording of investments has largely migrated from the balance sheet to the income statement. An investor’s job has not changed but the analytical approach has.
We discuss three essential aspects related to the rise of intangible investments. The first is how to measure them. We need to understand what defines an intangible investment, how the mix of tangible and intangible investments has changed over time, and how to accurately compare companies that invest primarily in intangible assets to those that invest in tangible assets.
Second is the characteristics of intangible assets. Economists have for decades explored the differences between intangible and tangible assets. Investors do not need to rewrite economic theory. They just need to grasp the nature of non-rival goods.
Finally, we explore the implications for investors. One example is the usefulness of earnings. Investments that are recorded on the income statement reduce earnings and can even lead to losses. A reallocation of those investments to the balance sheet leads to higher earnings and invested capital. Comparing today’s valuations to those of the past using simple metrics such as a price-earnings or price-book multiple can lead to misleading or faulty conclusions.
You can read the entire paper here:
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