Where Did That $730 Billion Of Intangible Investments Go? by Eric Bush, CFA – Gavekal Capital
Last year in the United States, $730 billion dollars were invested into intangible assets according to the BEA. Or put another way, nearly 32% of all domestic business investment in the US was intangible in nature. Guess how much of this $730 billion can be found on the statement of cash flows for US companies in 2015? Zero.
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The composition of business investment, in the US but also around the world, has been shifting over the past four decades. Corporations have been shifting from a tangible investment base to an intangible investment base. Since 1970, investment in intangible assets have been growing at a faster annual rate than investment in equipment (8.72% CAGR vs 6.41% CAGR) or structures (8.72% CAGR vs 5.75% CAGR). Yet since the the introduction of accounting rule SFAS #2 in 1974, all intangible investments have been treated as a current period expense and have not been capitalized as an asset. This has created a gigantic information gap between investors and corporations regarding the true nature of a company’s investments and the composition of its asset base. For many companies the amount of money invested in intangibles can be as much as 5x or 6x the amount invested in tangible assets (or as the table below shows for some companies the investment in intangibles can be even greater). Intuitively, this makes sense as growth increasingly comes from the unique intangible capital stock a company internally generates. To understand this, lets take a step back and think about the two basic ways a company can increase revenues. They can either find untapped markets and increase the quantity of product that they sell or they can increase the price of the product. In either case, substantial and persistent investments in intangible assets take place. In order to increase market share, companies must have an efficient logistic system to reach “nontraditional” markets and must have a trust worthy brand in order to convince consumers halfway around the globe that their product is the one they should buy. If a company is trying to increase the price that they sell their product at, they must give consumers a reason to pay a premium over close substitutes. In order to create a differentiated product a company must invest in research and development, technology and employee education to disrupt the current marketplace. Regardless of the type of intangible investment a company undertakes, the point is they are investing in the future and that under current accounting rules these investments, and the subsequent long-term assets created from these investments, are invisible to investors. This means for investors that are aware of the impact intangible investments are having on the 21st century corporation, there is opportunity in the market that can be exploited called the Knowledge Effect.
Example Of 15 Companies That Invest Many Multiples More In Intangible Investments Than Tangible Investments Each Year