We’re looking at it all wrong: the intangible information gap

October 18, 2011 by  

I have been really heartened to see more attention to the way that the intangible information gap skews investors’ understanding of what’s really going on in today’s knowledge-driven companies. This latest article comes on the heels of a Reuters piece last month calling for getting intangibles on the balance sheet.

Yesterday, this new examination came in Jeff Saut’s Market Call column where he quoted Steve Vannelli of the GaveKal Platform Company fund talking about technology and intangible capital (I added the bold):

To this technology point, I asked Steve to discuss his “knowledge,” or intangible capital, theme. He responded by stating that our current accounting system doesn’t value “intangible capital accumulation” appropriately. Most certainly, intangible capital accumulations are “expensed,” not capitalized. Such accumulations increase productivity, foster more efficiency, and drive better financial money flows than are currently measured. Moreover, if you are not measuring such metrics correctly, you are also not measuring our country’s “economic output” correctly. For example, “What is Amazon’s (AMZN) “search engine” worth? It is certainly worth something. But, it is currently carrying no value on AMZN’s balance sheet. Or, how about Apple’s (AAPL) iTunes? Hereto, iTunes has no value on Apple’s balance sheet. Ladies and gentlemen, our current accounting system ascribes no value to companies building “intangible capital” and thus it is mis-valuing many companies. Manifestly, if you are not measuring a company’s accumulation of “intangible capital” correctly, you are undervaluing corporate America. Currently, Federal Reserve reports show that $1.5 trillion worth of intangible capital accumulation is being not being recorded, which means our nation’s GDP output is not being calculated correctly either. Our sense is the path ahead is going to be better than most economists expect. Companies from our universe that spend an oversized amount of money creating “intangible capital,” and are rated Strong Buy by the covering fundamental analyst, remain: Read Jeff’s column to see the stocks he recommends

What Steve calls intangible capital accumulation, we call i-capex or intangible capital expenditure. That’s what it really is: investment in the infrastructure upon which the future earnings of a company will be produced. There’s nothing really intangible about it. It’s not bricks and mortar but it’s truly infrastructure.

We know that 80% of the value of the average company today is not represented on its balance sheet.  So it’s obviously not enough to just rely on financial statements to understand what is going on in a company. You have to get at the intangibles. What we in the IC field emphasize is that this process of examining intangibles should be systematic. That’s all. No magic. Just paying attention to what’s really important.


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