Brand Strategy Insider is generally an excellent resource for balanced thinking about branding and its role in business success. But today’s posting on “Brand Equity and The Center of Value” is an exception because it claims to provide proof of the value of branding while displaying a profound ignorance about finance.
As regular readers will know, I am committed to the cause of championing the strategic importance of branding and marketing based on my belief is that value has to be created before it can be captured. Value creation involves understanding customer value (the focus of Marketing) while value capture involves understanding how to configure your business to deliver customer value at an attractive economic cost (the focus of Finance). Both disciplines are necessary for the business to succeed.
For marketers to be credible as business professionals (a goal often expressed as “earning a seat in the boardroom”), it is essential that we display a decent grasp of finance. Posts like the one on Brand Strategy Insider today merely confirm the suspicion of many business people that marketers are willing to use finance-speak without really understanding the concepts and how businesses value is generated and measured.
“Brand Equity and The Center of Value” contains three fundamental errors:
- It defines intangible value as the difference between market capitalization and total assets
- It asserts that price-to-earnings is a reflection of high levels of intangible value
- It reveals an ignorance amount how investments are recorded on the balance sheet
Let me address each in turn.
The fundamental principle of a balance sheet is that Assets = Liabilities + Equity. In other words, Equity is the difference between the assets of a business and its liabilities.
Defining intangible value as the difference between market capitalization and total assets means saying Equity = Assets. It means totally ignoring the liabilities of the business! This error is best illustrated by using a bank as the example – it is equivalent to saying you could acquire all of a bank’s assets (its loans) for the price of its shares. For example, Bank of America’s $2.15 trillion of assets (as at Sept 30, 2015) could be acquired for $181 billion of equity. You are completely ignoring the depositors whose nearly $2 trillion of deposits provided the money for these loans!
Intangible value is correctly defined as the difference between what you would need to pay to acquire the company from its existing owners (the investors and lenders) and what you receive in terms of tangible assets (inventory, work in process, machinery, buildings and land, plus any net cash). This is calculated by subtracting as the net tangible asset value of the business (the sum of its net working capital and its investments in fixed assets [PPE – property, plant & equipment]) and its enterprise value (the sum of its market capitalization and total debt minus its cash).
The correct figure for Apple’s current intangible value is $490 billion. This is the difference between its $685 billion in enterprise value ($660 billion of market capitalization plus $25 billion of net debt) and its net tangible assets of $195 billion ($9 billion in net working capital plus $22 billion of PPE plus $164 billion of long term investments).
A “P/E” ratio expresses the multiple that a company’s shares trade at relative to the most recent earnings per share (this is more accurately described as a “trailing P/E” to distinguish is from the “forward P/E” that calculates the multiple relative to its expected earnings per share for the next reporting period).
P/E is therefore a comparison between a component of the Income Statement (the company’s earnings) and the current market price of its shares. P/E has nothing to do with the balance sheet and, therefore, cannot be used as an indication of intangible value. A high P/E multiple merely means that the company’s earnings are expected to grow significantly.
Accounting for Investments
The post suggests that the apparent $140 billion decline in Apple’s intangible value between 2014 and 2015 reflects “major investments in cloud services, iWatch, iPhone, their new corporate headquarters”. Only the last of these will definitely increase the tangible asset base of the company because it involves increasing the recorded value of Apple’s property, plant and equipment (as noted above, this is currently only $22 billion). Unless Apple is building its own data centres or factories, the investments in cloud services, iWatch and iPhone will not show up on the balance sheet.
I realize that some marketers will read this post and will think that I am splitting hairs to insist on using the correct definition of financial terms. There are two answers to this:
- First, credibility in the boardroom requires that marketers display an accurate understanding of finance – not just a willingness to band around terms like “ROI” and “intangible value” and “P/E” in an attempt to sound financially literate
- Second, on a simply behavioral level, it is really annoying for any discipline to have its terminology used incorrectly. Just as marketers get upset when their colleagues in other departments use “logo” and “brand” interchangeably, or confound “advertising” with “branding” or “promotions” with “marketing” so finance folk get upset when their terms are mis-used. The difference is that they control the purse strings…