The Value of Intellectual Capital

A recent post by Pat Sullivan prompted salutes here by IP Think Tank and here by IP Finance. Basically, Sullivan says that the current financial crisis “busts an intellectual capital myth,” that the value of intangible assets is the difference between the market value of a company and its tangible assets. It is from this approach that many of us often say that 70-80% of the value of a company today is intangible.

Sullivan entreats his readers, “I hope the recent vertiginous slide in stock prices will cause you to reconsider.”

I’m not convinced. The market does not value companies by looking at their balance sheets. In most cases, it never has. But I have always found the comparison between corporate valuations and tangible book value to be a powerful way of illustrating the shift that has occurred in recent decades. What Sullivan does not say is that until the 1970-80′s, corporate valuation tracked close to tangible book value. Over time, valuations rose way beyond book value and the gap grew to 80%, although this obviously varies with the rise and fall of the stock market. If you want to see graphs of this shift, check out this white paper by Ocean Tomo.

So what does that gap mean? Sullivan dismisses as naive that it is intangibles. It is not literally. But I think that intangibles drive that gap. Essentially, over time, companies all across our economy have been producing more and more value, greater and greater earnings, using fewer tangible assets. So the earnings from intangible-based business (earnings do drive stock prices) have pushed corporate valuations up from the traditional limit of their tangible assets.

It is through earnings that valuations of intangibles are performed today, for mergers and other events that require accountants to put intangibles on a balance sheet. Most analysts don’t like these intangibles. I don’t blame them. Mixing assets booked at cost with assets booked based on “value” makes for a messy presentation.

So Sullivan is right. It’s too simplistic to rely on a stock market gap to value intangibles. But it is also wrong to dismiss this gap as an illusion. While not an exact measure of intangibles, it is unmistakeable evidence  of the presence and importance of intangibles in our economy. Until we develop more exact methodologies of valuing these critical assets (read my thoughts on starting with cost here), let’s not abandon a tangible and visible evidence that there is more to our economy than we can currently see on the balance sheet.