Intangible Assets on the Balance Sheet
Analyzing a Balance Sheet
Now we arrive at intangible assets on the balance sheet. Companies almost always end up owning assets of value that cannot be touched, felt, or seen. These intangible assets, as they are called, consist of patents, trademarks, brand names, franchises, and economic goodwill, which is different than the accounting goodwill. Economic goodwill, which is frequently referred to as franchise value these days, consists of the intangible advantages a company has over its competitors such as an excellent reputation, strategic location, business connections, etc.) While every effort should be made for businesses to carry these intangible assets at costs on the balance sheet, they are sometimes given what amounts to near arbitrarily meaningless values.
To prove the point that the intangible value assigned on the balance sheet can be deceptive, here's an excerpt from Michael F. Price's introduction to Benjamin Graham's "The Interpretation of Financial Statements,"
"In the spring of 1975, shortly after I began my career at Mutual Shares Fund, Max Heine asked me to look at a small brewery - the F&M Schaefer Brewing Company. I'll never forget looking at the balance sheet and seeing a +/- $40 million net worth and $40 million in 'intangibles'. I said to Max, 'It looks cheap. It's trading for well below its net worth.... A classic value stock!' Max said, 'Look closer.'
I looked in the notes and at the financial statements, but they didn't reveal where the intangibles figure came from. I called Schaefer's treasurer and said, 'I'm looking at your balance sheet. Tell me, what does the $40 million of intangibles related to?' He replied, 'Don't you know our jingle, 'Schaefer is the one beer to have when you're having more than one.'?'
That was my first analysis of an intangible asset which, of course, was way overstated, increased book value, and showed higher earnings than were warranted in 1975. All this to keep Schaefer's stock price higher than it otherwise would have been. We didn't buy it."
How to Analyze a Balance Sheet
When analyzing a balance sheet, you should generally ignore the amount assigned to intangible assets or, at the very least, take it with more than a grain of salt. These intangible assets may be worth a huge amount in real life but the recorded accounting value probably doesn't approximate it to any degree of meaningful accuracy.
Consider The Coca-Cola Company. Although it only has around $12.6 billion in net property, plant, and equipment on its balance sheet as of the end of the third quarter 2015 (the official full-year 2015 figures have not, yet, been released), if the whole firm went up in smoke tomorrow, it would easily take $100+ billion to replicate its existing infrastructure, facilities, and distribution network; the difference of which shows up nowhere on the balance sheet. At the same time, the firm carries more than $13 billion in intangible assets on the books. That $13 billion includes things like the Coca-Cola brand name and logo, which are undoubtedly very, very valuable. If you woke up tomorrow without a single asset to your name except for that trademark, you'd instantly be a billionaire because investors would want to buy it or license it from you as it will lead to exponentially higher beverage sales thanks to more than a century of brand equity building through marketing, positive experiences, and positive associations.
The Importance of Intangible Assets
For some firms, intangible assets are the engine behind the business. A perfect illustration: The Walt Disney Company. Nobody else can legally manufacture and sell the thousands of original characters and stories it owns; a right that entitles it to open theme parks built around them, sell merchandise such as lunch boxes and coffee mugs, put on live concerts and release albums.
Disney carries shy of $7.2 billion on its balance sheet for intangible assets, though it's certainly worth more.
How, then, should a person estimate the value of intangible assets? For a private investor acquiring shares in a firm that he or she does not control, such as picking up blue chip stock, Benjamin Graham argued along the lines that to be of any use, the real value of the intangible assets must show up in the superior performance figures of the income statement, balance sheet, and cash flow statement, otherwise they aren't worth much at all; that by treating the intangible asset as another source of value rather than focusing on the cash flows it produced the analyst is, in fact, "double counting" the benefit. His most famous student, billionaire investor Warren Buffett, later went on to take a slightly different approach, insisting that, sometimes, the value of the brand was sufficient in that you could qualitatively know declines in revenue were far less likely during periods of economic stress, therefore making it wise for the investor to pay a higher, close-to-fair value price for the enterprise rather than seeking a discount.
In other words, you may not, precisely, know the true value of Disney or Coke's intangible assets but if either firm is trading at fair value or lower, and you have a long-term ownership period of 5, 10, 25+ years, it might be better to buy it knowing that the intangible assets are a sort of additional margin of safety.
Intangible assets are non-physical assets that provide value or a marketplace advantage and are deemed to have a useful life of more than one year. Intangible assets consist primarily of intellectual property, such as copyrights, patents, customer lists, brand recognition, trademarks and franchise or licensing agreements. The useful life of an intangible asset can be either identifiable or non-identifiable. Proper valuation and accounting of intangible assets is often problematic, due in large part to the way in which intangible assets are handled.
According to guidelines set forth in generally accepted accounting principles (GAAP), intangible assets are only listed on a company's balance sheet if they are acquired assets and assets with an identifiable value and useful lifespan that can thus be amortized. Internally developed intangible assets do not appear as such on a company's balance sheet. Even though an intangible asset such as Coca-Cola's logo carries huge name recognition value, it does not appear on the company's balance sheet because the logo was developed internally and does not have a price that can be used to assign fair market value, as would be the case had the logo been part of the acquisition of another firm.
When intangible assets do have an identifiable value and lifespan, they appear on a company's balance sheet as long-term assets valued according to their purchase prices and amortization schedules. For example, if a company spent $10,000 to purchase the right to use another company's customer list for a period of 10 years, then $1,000 of the purchase price would be expensed each year, and the value of the customer list license would appear on the balance sheet in year three as $7,000.
Intangible assets with a theoretically infinite life, such as goodwill, cannot be amortized and therefore do not appear on the company's balance sheet.