Investors are rethinking how they define value as intangible assets like intellectual property play an increasingly large role in the success of companies. But not even intangibles can explain the soaring stock prices of big tech companies, according to Research Affiliates.
“Mega-cap growth stocks, notably, the FANGs, still look expensive after incorporating intangibles in the value of firm capital,” Research Affiliates’ Brent Leadbetter, Feifei Li, and Juhani Linnainmaa wrote in a new paper.
The trio examined the FANG stocks — Facebook, Amazon, Netflix, and Google-parent Alphabet — as part of an analysis of how intangible assets can change the value calculation for companies with high levels of research and development. Such assets are not included on company balance sheets, and therefore don’t factor into the traditional metrics used to define value, including the ratio of price to book value.
“As intangible assets such as knowledge, intellectual property, and human capital become more important to firms’ successes, intangibles’ share of total company capital has grown meaningfully,” they wrote. “In 1963, the average firm’s intangible assets were roughly 30 percent of the size of its book value of tangible assets. Today, intangibles represent nearly 100 percent of the average firm’s tangible book value.”
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IBM, for example, was found to trade at nearly twice the price of the average large-cap company, based on its price-to-book ratio alone. But when the tech firm’s R&D was incorporated into its valuation, the Research Affiliates group found that IBM stock traded “at a sliver of a discount.”
The same could not be said for all tech companies, however. Amazon, which had the highest R&D spending of any U.S. firm, appeared “quite” pricey even after accounting for its almost $94 billion in capitalized research and development, according to Leadbetter, Li, and Linnainmaa.
“After we include R&D spending, it remains expensive at nearly 4.5 times the price of the average company,” they wrote. “Amazon is not the only exorbitantly priced company that still looks extremely expensive after incorporating R&D.”
Amazon, Netflix, and Alphabet also continued to trade at premiums after adjusting for the value of intangible assets. The Research Affiliates trio determined that the Google parent company was the least overpriced of the group, trading at less than twice the price of the average firm after accounting for R&D.
“Incorporating intangibles can make the valuations of some growth firms appear more reasonable, yet expanding beyond book value to a more complete measure of firm capital will not change the fact that some companies are expensive today regardless of the metric used to evaluate them,” the authors concluded.