Posts tagged ‘Book value’
I went to a very interesting event in London a few weeks ago. It was arranged by Human Potential Accounting and the event was titled “The Future of Investment: Human Capital”. A panel composed of people from different parts of the investment community – private equity, regulators, pension funds, investment banks etc. – discussed how much they use Human Capital when assessing the value of companies. The topic is ever relevant and interesting.
When I think back upon my time as financial analyst in London, I remember that a lot of our valuations was based upon gut feeling. This gut feeling (should PE be 15x or 17x) had a great impact on valuations and much of it came down to Human Capital. It was soft, people stuff such as ‘ability to execute’, ‘trust in management’, ‘aligned organization’, ‘ability to change’ and ‘ability to innovate’. I never tried to put an exact value on these things, but I would write things such as “I do not believe the management will be able to deliver on this strategy” or something like that.
About 80% of the market value of a stock is not accounted for by the tangible assets on the balance sheet. In the early 80’s this figure was closer to 40%. So clearly the intangible value matters more today that they did 30 years ago. Human Capital is without doubt one of the most important intangible assets.
So when people ask “is Human Capital actively used in valuing stocks today” the answer is both ‘yes’ and ‘no’. No, I never see an explicit value put on any parts of Human Capital and it is never capitalised on the balance sheet. But ‘yes’, people issues matters a lot when investors, analysts and companies assess the market value of a company.
Book value accounts for about 20% of a company’s market value today. The rest – 80% – is down to immaterial ‘assets’. This makes valuing companies very difficult indeed.
There are many good reasons why book value always will be lower than market value. However one way to close this gap – and thereby making the value more transparent – is to capitalize more of the immaterial value. This could be ‘Brand Value’, ‘Customer Loyalty’ or ‘Innovation’. All of these things obviously makes a company worth more. However, one candidate stand out to me – people or ‘Human Capital’.
Why ‘Human Capital’ is a strong candidate is because it accounts for the bulk of the cost for most companies today. For some it is about 75% of total costs. It is also universally recognised, that people and their ability to perform, is the single most critical reason behind value creation today.
How practically this should be done is quite difficult to say. One way is to capitalise the total cost of the people including wages, pension, recruitment, training etc. But many questions are difficult: Should people be depreciated? If you spend money training them, should this be capitalised as any other investment? What happens when somebody leaves – should a cost be booked on the income statement? Can you ‘buy’ people below their value and should this be a gain on the income statement? How do you measure the value of people (if you don’t just use the cost base)? Some people are clearly worth different to the company despite perhaps getting the same pay – how should that be accounted for?
Perhaps these questions illustrates why Human Capital is not capitalised today. It is simply too difficult to find a meaningful way forward. But I would like to see a good, public debate about this. Perhaps there is a way?