Factors to consider for true value investment

Financial Analysts Journal

The graph above is a graph showing the change in corporate valuation presented by the Financial Analysts Journal report. This graph shows that the investment in tangible assets is beginning to decline in the assets of major US corporations.

The proportion of tangible assets, which was 15% of the total in 1977, has drop to 9% in 2014. Conversely, investment in intangible assets is increasing from 9% to 15%.

In other words, it shows that the current economic structure is changing from Asset-Heavy Industry to Asset-Light Industry or Knowledge/Information Inustry.

In the past, the companies predicted demand, invested in facilities faster than its competitors, and made a lot of money in the up-cycle of the economy.

On the other hand, technological change is accelerating and global competition is accelerating, and constant innovation and product development are required for continuous prosperity of companies. To this end, the companies are constantly engaging in brand advertising and M&A to increase our R&D investment and brand value.

How about looking at this phenomenon from an investment perspective?

Investments in tangible assets are accounted for as an asset in the statement of financial position and are subsequently amortized over 5 to 20 years. On the other hand, investments in intangible assets are partially treated as assets and a significant portion are treated as expenses.

For example, if R&D is increased, labor costs for R&D personnel, outsourcing costs for R&D and research materials will be treated as expenses. The same is true for advertising for branding. The statement of financial position is treated as advertising expenses.

As a result, investment in intangible assets is more conservatively reflected in current costs than investment in tangible assets that companies have been in the past. This fact can be of great value to value investors. Many value investors use the PER indicator.

At present, investment in intangible assets is higher than tangible assets. Conservatively accounting for them increases the reflection of costs compared to the past. This in turn has the effect of reducing net profit.

In this case, profit will decrease and PER will increase. Therefore, if we judge based on PER simply, the share price of the company does not seem cheap. However, companies that invest heavily in intangible assets are those that are investing in the future. Therefore, it is necessary to properly evaluate the future value of the company.

As investors, we always consider assets and take ROE. ROE is always valued by estimating the size of the asset and the efficiency of the asset, since the asset is the basis for future profits. However, as investment in intangible assets increases, assets are underestimated and asset efficiency becomes undervalued compared to tangible assets.

Judging the value of a company through low PER or low PBR is not a value investment. It is a very useful investment method, but it is an “investment technique” based on a specific value indicator, not a philosophy of value investment.

Ultimately, if you are a value investor, you need to evaluate the value of an enterprise by looking at the investment in intangible assets rather than investing in tangible assets. Simplifying the value calculation is useful in terms of saving time, but there is a high probability of a mistake. To truly invest in value, we must constantly study. The methods that were useful in the past may not be useful in modern times.

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