In the post-pandemic world, the growing importance of intangible assets is reflected in company earnings. Even startups and smaller businesses with limited assets are currently fetching exceptionally high premiums over their historical averages.
Commenting on the latest EverEdge Intangible Benchmark Index, EverEdge Global CEO Paul Adams says, “This research affirms that intangible assets are the most important drivers of company growth and value today.”
The EverEdge study identifies the relationship between intangible assets such as patents, design rights, systems and processes, relationships, and business growth and value, a trend that is expected to continue as digitisation accelerates in post-pandemic economies.
The S&P 500 recorded the largest share of intangible assets relative to enterprise value at 85 percent in 2020 and has seen a steady increase of intangible assets as a percentage of enterprise value from 2000 to 2020, according to the new research.
Analysis of the S&P NZX All Index and the S&P ASX 200 in New Zealand and Australia also found a consistent rise in the share of intangible assets over a 15-year period.
“Over the twenty years of the study, the data shows how capital has (consciously or unconsciously) actively and disproportionately rewarded intangible asset-rich companies,” explains Paul.
“It has done so because, other things being equal, companies that are able to harness the inherent scalability and differentiation of intangible assets to growth orientated business models will generate outsized performance.”
What are intangible assets?
Intangible assets are assets that cannot be touched, such as software, trademarks or goodwill. They are an investment that a company can amortize over a variable period of time.
These include brand value, consumer data, human resources, software, patents, and contracts. Investors place more emphasis on these than on tangibles such as land, buildings, machinery, cash, and bonds.
Intangible assets are knowledge-based assets that are sources of future economic benefits, contribute to individual SMEs’ uniqueness and provide sources of competitive advantage.
They have a greater impact in new-age digital businesses, where financial measures and traditional methods of evaluating business value have failed to explain their unicorn status.
Companies with essentially no actual assets but very strong brand value based on proven business methods can have nearly the same market valuation as large entities.
How can SMEs identify their intangible assets?
“The inherent benefit that intangibles have over tangible assets is that they are potentially infinitely scalable,” Michael Masterson, Managing Director of EverEdge explains while speaking with Dynamic Business.
“Every company starts as an idea. What enables you to scale is your intangible assets and your ability to defend them. But the way that you maintain not just market share, but also company margins, is you should be able to defend that territory.”
So if you’re an early stage startup, what an investor wants [to understand] is how do I get a return on my investment?
“The classic mistake we find, not just small companies make but even in big companies, is that they don’t explain their intangibles, their competitive advantage. In other words, they talk about the idea – if it’s a good idea or a bad idea -but they don’t explain how they are going to attain margin or market share.
“It’s not just about how they will get people to buy their product, but also about how they will get people to keep buying their product. That was the classic mistake Uber made.”
According to Michael, the biggest error business owners make is that they only talk about the idea and don’t explain what’s going to stop everyone else from eroding their competitive advantage.
“It’s not just about having a great idea. It’s about making sure I stop everyone else copying my idea, so that the only differentiation is price. And that is often a little bit easier said than done.
“And it’s the intangibles that offer you that form of protection. And it’s not just intangibles, it’s the individual assets. It’s how I am going to differentiate my brand — my data, my systems, my processes, my knowledge.
“One of the examples that you often hear investors talk about is that they back the jockey, not the horse. What intangible assets are doing is making sure that the horse actually has legs. If so, How many legs does it have? How strong are the legs? In other words, you’ve also got to make sure that the intangible assets surrounding the idea will support and protect the idea..”
How to assess the risks associated with intangible assets
Intangible assets have significantly different risk profiles than tangible assets, Michael points out. “If you don’t know what the asset is, you won’t know what the risks are. However, once you know what asset you’re dealing with, you may start thinking about the risks that come with it.”
“The first thing is once you’ve identified what the assets are, then the risks are relative to the asset. And the example we use is, if you think about a building, any office building in any major city will be insured for fire. But obviously, it’s not insured for theft. But if you think about it, the data that’s in those office buildings is incredibly valuable and vulnerable to theft, but invulnerable to fire.
“So let’s say you’ve come up with an incredible new formulation for a particular ingredient or recipe. Now, if you don’t protect it, then everyone’s going to know what that is. What you’ve got to do is you’ve got to keep it a secret.”
“And that’s why Uber hasn’t been able to capture the value of their intangible assets. All of the other rideshare companies have benefited from all their hard work and their capital.”
Turn intangibles into legally valued assets
Michael says that if investors want to achieve exponential returns, they can’t do so with tangible assets alone, hence they must invest in intangible assets.
“A lot of people have mobile phones, and Apple didn’t invent the mobile phone. But what Apple does have is the Apple ecosystem. If you want access to the Apple ecosystem, you need an Apple product.
“And that’s the scalability part. The mobile phone is tangible, the intangible is the App Store and the content that you can get. But you need an Apple product to do that.
“And that’s why Apple is valued and can charge a premium. People are prepared to pay a 30 or 40 per cent price premium because it’s an Apple product, and it gets them access to the Apple App Store.”
The EverEdge Intangible Benchmarking Index
The EverEdge Intangible Benchmarking Index (EIBI) examines the evolution of intangible assets across four major stock indexes at both the index and sector levels.
EverEdge has purposefully expressed intangible assets as a percentage of a company’s enterprise value rather than market capitalisation, which provides a more accurate measure of the capital required for any business because it includes the debt the company incurs to finance its operations.
Paul Adams explains, “Expressing intangible assets as a proportion of enterprise value yields a lower and slower-moving number than if it was compared to equity. However, it is a more robust expression of the importance of intangible assets for company valuations and deliberately and perceptibly neutralises the effect of financing choices.”
Key findings from Australia
The lack of growth in intangible asset ratio in Australian markets compared with US markets reflect intangible asset-rich companies’ preference to seek capital in the US. According to Michael, listings into the US market are driven by the better relative recognition of such assets in the US market and the greater amounts of capital allocated to such companies.
“The value of a company in the US is higher than Australia partly because the US is a much bigger addressable market. But I also think US investors are a little bit more evolved, in particular when it comes to intangible asset rich companies. I think US investors understand this market better than, say, Australians.”
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