“It’s stated here in black and white” is sometimes the turn of phrase when referring to hard facts. It was long assumed that if something was in print then it must be accurate. The same goes when it comes to evaluating companies. The most rational way to evaluate a company is to look up its annual accounts and look at the hard facts. True – annual accounts are indeed seldom mistaken. As a matter of law, they are verified and signed by an auditor. On the other hand, just going through the published number is a very narrow way of evaluating the future worth of a company and can be done quite quickly and cheaply using machine learning or artificial intelligence. Indeed, the only proper way of valuating a company is to read between the lines to assess the hidden inner value of the operation. This especially applies to intangible assets. They include trademarks, patents, goodwill, licenses of various kinds, human capital, and reputation, to name a few. These assets are often hidden behind the numbers and must be analyzed subjectively, each in its turn. For it is precisely here, in this valuation, where the wheat is separated from the chaff in long term investments in the stock market.
Listed companies have an extensive obligation to provide information. Today, quite detailed financial information is available to the public regarding each listed company. On the internet, there are also websites like Yahoo Finance, Bloomberg, CNBC, and Keldan in Iceland, where this financial information is analysed. Furthermore, one can also find their various coverage of the companies and their management. Thus, there is no shortage of figures on screens. However, the more information that is available, the more complicated it is to make investment decisions based thereon. This problem will only become exacerbated with the arrival of artificial intelligence and various algorithms. The fact is, simply, that when the investor is faced with having to select an asset for their portfolio, they have many comparable companies to choose from. The danger, obviously, is that the bird’s eye view over the forest will become lost in the multitude of trees.
But how to valuate intangible assets? How can one predict the popularity of a product or service? How can one predict which companies will become an industrial leader? – Indeed, who could have predicted the growth of Lululemon Athletica, Decker’s Outdoor, and Shopify, to name a few up-and-coming companies?
The simplest way to valuate intangible assets is to deduct their book value from their market value. This method is, however, not very reliable and is not easily transferable between different industries. Worse, this method reflects the assessment of the market which is reflected in the share price. Therefore, it is based on chasing the market. Each investor must make her own independent assessment when picking stocks, if they are to have any hope of beating the market.
In order to reach that goal, one needs to read between the lines in the annual accounts of companies and assess the future value, considering the competitive advantage which the intangible assets of the company generate.
Intangible competitive advantages are not a new phenomenon. Companies like Microsoft, Apple, and Coca Cola all enjoy such an advantage. Microsoft’s advantage, considering its size and technological monopoly which traps customers because all others use the same tech and, therefore, the cost of changing service providers is enormous. Apple also has an edge because of herd mentality and brand strength, and Coca Cola because of the often-mentioned industrial secret. This advantage yields more customer loyalty and the ability to set prices high without people taking their business elsewhere.
One good example is the shoe brand Hoka, which has garnered a fine reputation within the running community. Hoka came into being in the French Alps in 2009. The aim was to enhance the comfort and safety of those who run in the mountains without sacrificing speed. Comfort with a thick sole and bright colours are the hallmarks of Hoka. Deckers Outdoor acquired Hoka in the year 2013, and today Hoka comprises 39% of Deckers Outdoor sales. Admittedly, Hoka shoes are good, but the best feature of Hoka is its strong reputation, built on the basis of quality and performance. The strong reputation of a brand not only yields increased sales but also provides a competitive edge and is therefore to be defined as an intangible asset of the company, to be assessed as part of its value.
The best way to assess the value of intangible assets is familiarity with the industry to which the company belongs and extensive knowledge of its operational environment. However, the old adage holds true that the devil is in the details. Today’s production processes are complex, but each company has in some form or the other a comparative advantage that have not only ensured survival but profit and growth in their respective sector. This advantage as to be understood and analyzed in order to pick a winner in each fray.
Also, it’s important to trust one’s intuition regarding various human factors which determine the success of companies, such as the vigour of the executive committee and so on. Intuition is a thing to be acquired from experience, whether from success or failure, in selecting companies. The bottom line may be that the key to stock picking may be an understanding of the rising trends and fads guiding the purchasing behaviour behind the figures. In that respect, people will always be more successful than computers.
The author is an investor and the owner and fund manager of Spakur Invest. Spakur Invest invests in valuable, resilient, international companies which the fund intends to own for a long time.
