Posts tagged ‘Intangible assets’
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.
Looking through financial statements today it is clear that there is a huge gap between what companies say are their most important asset – people – and what they report in their financial statement – tangible assets, products etc. Financial regulators – such as SEC and FSA – as well as stock exchanges are not much better. They demand certain items to be in the financial statements but not one demand information about people. This is amazing when you consider that more than 80% of the market value of the average S&P500 company is intangible assets i.e. above the book value of a company.
I think a major reason has to do with the fact that no credible standard has been put forward. If a company wanted to show the value of their software developers, sales people and marketing departments as well as receptionists and top managers how should they account for this? By number of people? By total cost of the people? And how do you show investments into this asset base and what about depreciation of it? Does CROIC (Cash Return On Invested Capital) make sense for people or do we need completely new metrics? I just don’t think they know.
Luckily a bunch of really good initiatives are underway to try to come up with standards for accounting for people. An interesting White Paper about this topic can be downloaded here: http://hcminst.com/articles/
I believe it is very important to come up with global standards for financial accountability of human capital. Today it is impossible for investors to have any feel for the quality of software developers at company X compared to company Y. The financial accounts today simply does not begin to describe this important asset base. How should investors and owners understand what they have invested in?