Traditional metrics like P/E and P/B are effectively broken
Outdated accounting standards create ‘distortions’ in equities
And it’s not just talk. Practitioners now regularly adjust models to give greater heft to things that were previously thought too abstract to value. By treating specific kinds of intangibles — those funded internally, that solidify a strategic advantage — as investments, fund manager Knowledge Leaders Capital LLC says it sees $3.4 trillion extra book value on the balance sheets of the roughly 3,000 stocks it studies, causing the price-to-book ratio to fall by 14 percent.
After the adjustments, Autodesk has $7.8 billion of assets, compared with the $4.2 billion on the books in the same period. Its 2018 losses are 21 percent smaller than reported.
It’s a hallmark of American accounting that the value created by things like advertising or research and development go largely unrecognized when counting up net worth, while eating into earnings.
Here’s how it works. When a company splurges on developing software, accounting treats it like renting office space: you’re spending money to keep the business going, but not acquiring anything with future benefits. If you buy a building, however, that becomes an asset on the balance sheet, its cost spread over a long time.
Not recognizing intangible assets can push down both profits and book value in businesses that depend on research and marketing, which are increasingly important in the global knowledge economy. Just think Tesla Inc., Nike Inc. or Gilead Sciences Inc.
“You’ve got all these assets that don’t show any value in their financial statements that are just becoming more and more valuable in today’s society,” said Travis Fairchild, a fund manager at O’Shaughnessy Asset Management in Stamford, Connecticut. “We’ve moved from an industrial marketplace to much more of a technology and intangible asset industry, and that’s just creating larger and larger distortions.”
Seems so similar to the dot-com boom’s “It’s different this time.”, “new economy”, and “The rules have changed”.