79.4% of Corporate Value is Intangible

TL;DR - Analysis of US non-financial companies with revenues and market capitalization greater than $50MM as at mid-October 2023 reveals that tangible assets account for only 20.6% of their enterprise value.

Longer explanation

For more than three decades now, I have been fascinated by the question of what represents the true resource base of a business (hint: it is not just the assets that appear on the balance sheet). This was the reason why I changed career from traditional, financially-oriented management consulting to creatively-oriented brand consulting in 1995 and what eventually led to the creation of Type 2 Consulting in 2006.

Intangible value analysis has been one of the centerpieces of my quest to get companies to recognize the importance of two types of asset that represent sources of future cash flow but which are generally not reported on the balance sheet. The two classes of asset are intellectual property and relationships.

My hypothesis is that the asset base of a business consists of three main types of resource:

1. What we own
2. What we know
3. Who we matter to

What we own: These are the tangible assets (fixed and working capital) that our Industrial era accounting rules do a good job of recording.

What we know: This is the knowledge base and human expertise that we use to develop products, services and business models that allow us to deploy our tangible assets in ways that generate an excess return on capital. This represents the intellectual capital of your business.

Who we matter to: These are the relationships we create that predispose people to do business with us - whether as customers, suppliers, distributors, or employees. This represents the emotional capital of your business.

Intangible value illustrates the divergence between the value of "what we own" and the observed value of the business in the marketplace. It represents the combination of two things - the value of the intellectual and emotional assets that do not appear on the balance sheet (what we know; who we matter to); and the difference between the historic and mark-to-market value of the assets that are reported on the balance sheet.

I know that many people like to quote the statistic that says that tangible assets represent less than 10% of the value of the S&P 500 and that this figure used to be 85% back in 1975.? The direction of the trajectory is correct (computers and digitization have led to a dramatic increase in intangible value) but the actual magnitude of the shift is not as large as this.

[For those of you who want an explanation - the 10% and 85% figures appear to derive from simply inverting the "P/Tang BV" ratio for the S&P500. If this ratio is 10, this means that "Tang BV" is only 10% of P. The flaw in this argument is that "Tang BV" measures the tangible book value of equity, not the tangible book value of assets. The increase in the "P/Tang BV" ratio reflects the fact that companies have been reducing their book equity through buybacks and the goodwill paid in mergers faster than the rate of new equity issuance. This decline in Tang BV, combined with the rise in P from the growth in the multiple of revenues at which companies trade, results in this dramatic change of the P/Tang BV ratio.]

The more accurate number for the proportion of enterprise value represented by the tangible assets shown on corporate balance sheets is 20.6%

Here's the data behind that calculation:

Aggregate data

As at 15 October, there were 2,062 publicly-listed US companies with revenues and market capitalization greater than $50MM.? Together they represented $32 trillion of equity value and accounted for 70% of the aggregate value of the NYSE and NASDAQ.

These companies generate $15.5 trillion in annual revenues with a net income margin of 7%.? Their operating cost base consists of Cost of Goods Sold (68 cents per dollar of revenue); Sales, General & Administration Costs (16 cents); R&D (3 cents); Financing and Tax Costs (6 cents).

They have total assets of $21 trillion of which $6 trillion are current assets (those expected to be converted into cash within a year) and $15 trillion are long-term assets.?? Of these long-term assets, $6 trillion represent Property, Plant & Equipment while a further $6 trillion are intangible assets representing the premium paid during acquisitions ($2.5 trillion of specifically identified intangible assets and $3.5 trillion of goodwill).

This means that these 2,000+ companies require an average of 10 cents in working capital per dollar of revenue (current assets of $6 trillion minus current liabilities of $4.5 trillion supporting $15.5 trillion of revenue) plus 38 cents of tangible fixed assets ($6 trillion of PPE supporting $15.5 trillion of revenue).

The aggregate market capitalization of these companies was $32 trillion as at 15 October this year. Add in $5 trillion of net debt (debt minus cash and short-term investments) and you get to $37 trillion of enterprise value. Of this, only 20.6% is represented by the $7.6 trillion of tangible assets on the balance sheet. So 79.4% of corporate value is intangible - a not insignificant $29 trillion of value that merits some analysis!

Reported intangibles are of limited use

As noted above, these 2,000+ companies show nearly $6 trillion of intangible assets on their balance sheets.? This represents nothing more than the premium paid on past acquisitions. This data provides insight into which companies have historically been the most aggressive in terms of acquisitions (Answer: AT&T, Verizon, Comcast, Disney, CVS, T-Mobile and Warner Discovery – each of whom show more than $100 billion of goodwill and other intangibles on their respective balance sheets; together these 7 companies represent 17% of the aggregate value of reported intangibles).

This historical data is of limited use in explaining the overall $29 trillion of intangible value that represents the market's forward-facing estimate of the value created by these companies through their information, processes, technologies, business models and relationships.?

Understanding value creation

While the headline of “79.4% of enterprise value is intangible” makes for a good headline, the insight comes when you consider how much this figure varies by industry.

At opposite extremes are Technology and Infrastructure.? Tangible assets account for less than 8% of the value of the 159 Technology Hardware companies and 283 Technology Services companies; and less than 10% of the value of the 75 Food, Beverage and Tobacco companies.? By contrast, tangible assets account for 74% of the value of the 62 Infrastructure companies and 64% of the value of the 33 Construction companies. The chart in the header of this article shows the data for the other industries. Here is a table with the underlying data:

It is clear from this analysis that industries vary considerably in terms of the degree to which their productive resources take the form of financial and physical assets (what we own) versus intangible assets (what we know, who we matter to).

My current focus is on developing "norms" for the relative importance of each form of asset by industry. My big dilemma is which framework for intangible capital it is most insightful and practical to use. Grateful for any recommendations!

?