Evaluating the intangible assets of a company is a crucial part of the fundamental analysis, especially in a generation with a lot of leading companies in the technology and service-based industries.
However, most investors ignore this part and focus more on the physical assets like land, building, equipment, etc. One of the major reasons why people skip the part of studying intangible assets is because these assets are a little difficult to evaluate. After all, how would you correctly measure the value of a brand or non-physical assets of a company?
In this post, I’ll try to demystify intangible assets in simple words so that you can understand what exactly are intangible assets, why are they valuable for a company and how can you evaluate the intangible assets of a company.
Overall, it’s going to be an exciting post. Therefore, please read it till the end because I’m sure it will be helpful to you in assessing companies better.
What are intangible assets?
Intangible assets are those assets that are not physical in nature, yet are valuable because they contribute to the potential revenue of the company.
A few of the common examples of intangible assets are brand recognition, licenses, customer lists, and intellectual property, such as patents, franchises, trademarks, copyrights, etc.
Quick Note: Contrary to these, TANGIBLE Assets are those assets that have a physical form. For example- land, buildings, machinery, equipment, inventory, etc. Further, financial assets such as stocks, bonds, etc. are also considered tangible assets.
Although intangible assets do not have an obvious physical value such as land or equipment, however, they can be equally valuable for a company for its long-term success or failure.
For example, companies like Apple or Coca-Cola are highly successful because of the significant brand equity. Since it is not a physical asset and tricky to calculate the exact value, still brand equity is one of the primary reasons for the high sales of these companies. In India, companies like Hindustan Unilever, Colgate, Patanjali, etc also enjoy the benefits of enormous brand value.
Further, a few more examples of intangible assets can be marketing-based (ex- Internet domain names, non-competition agreements etc), artistic-based (ex- literary works, musical works, pictures etc), Contract-based (ex- franchise agreements, broadcast rights, use rights etc) and technology-based (example- computer software, trade secrets like secret formulas and recipes etc). [Credits: Examples of intangile assets- Accounting tools]
Moreover, in a few industries, intangible assets are more valuable:
Unlike manufacturing companies where inventories and fixed assets contribute to the majority of their total assets, in a few industries the intangible assets are more valuable:
- Consumer product companies depend on the brand name. For example- Hindustan Unilever, Godrej, Colgate, etc. The bigger the brand name, the easier are the sales.
- Technology companies get the most success by their technical know-how and skilled human resource. Ex- Infosys, TCS, etc.
- Banking companies have their computer software license, stock exchange cards and electronic trading platform (websites). Ex- HDFC bank.
- Telecom industries use their bandwidth licenses (including spectrum) to enjoy benefits. Example- Bharti Airtel
- Drugs and pharmacy companies protect their sales through patents, which means that they can sell unlimited medicines of patented drug and their competitors can’t enter or replicate the same. Ex- Dr. Reddy’s Laboratory, Glenmark Pharma, etc.
And that’s why the leading companies in these industries spend a lot of money in building these intangible assets.
For example, in the IT industry, training and recruiting are more prominent than investing in physical assets like buildings.
Similarly, pharmaceutical companies spend a lot of capital in the Research and development (R&D) which may help them get a patent on a revolutionary drug. And that’s why, while evaluating companies in this industry, the capital expenditure of the different companies/competitors in their R&D work should be carefully evaluated.
If you look into the consumer product companies, they spend a lot of money in advertisement just for brand awareness. Although, this may not lead to instant sales and may add overhead expenses, However, over the long term. branding help these companies to generate more profit.
Valuing Intangible Assets
The intangible assets of a company can be found on the asset side of the balance sheet of a company. For example- here is the intangible assets for Hindustan Unilever (HUL)
Source: Yahoo Finance
You can use the intangible to total asset ratio to evaluate the worth of intangible assets in a company. For example- in the case of Hindustan Unilever, its intangible assets make around 2.05% percent of its total assets.
However, valuing intangible assets are easier said than done. One of the biggest reasons equipment high sales of HUL in India is its prominent brand recognition. A few of the popular brands of HUL are Lux, Lifebuoy, Surf Excel, Rin, Wheel, Fair & Lovely, Pond’s, Vaseline, Lakmé, Dove, Clinic Plus, Sunsilk, Pepsodent, Closeup, Axe, Brooke Bond, Bru, Knorr, Kissan, Kwality the and Pureit.
Here, do you really think that the brand value of HUL contributes only around 2% of its net assets? I don’t think so. It must be worth more. However, there’s no easy way to correctly evaluate the worth of the brand recognition and other non-physical assets.
Quick fact: According to Forbes, COCA COLA’s brand value amounted to 57.3 billion U.S. dollars. It is the only company in the top seven list that sells carbonated sugar water beverages. Rest all are technology companies with Apple and Google as leaders. This is the power of branding. Read more here: The world’s most valuable brands.
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Although intangible assets do not have a physical presence, they add huge value to the company. There may be even cases where the intangible assets are of far greater value than the market value of the company’s tangible assets.
However, while valuing such companies, you may have to put some efforts to study these assets as the accounting conventions do not always value the exact worth of a few intangible assets and they may be reported below their true value in the balance sheet.
Anyhow, look for the intangible assets that are definite (i.e. stays with the company for as long as it continues operations) and difficult to replicate.
Kritesh (Tweet here) is the Founder & CEO of Trade Brains & FinGrad. He is an NSE Certified Equity Fundamental Analyst with +7 Years of Experience in Share Market Investing. Kritesh frequently writes about Share Market Investing and IPOs and publishes his personal insights on the market.
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