Intangibles like goodwill, licences and brand are not on the balance sheet, but they have their worth.
Thanks to conservative accounting and reporting policies, intangible assets of companies do not get noticed by many investors. These ought to merit attention. The difficulty is in valuing assets such as goodwill, licences, large advertising expenditure, development rights, patents, brands, intellectual rights and research and development pluses.
Most of these do not find any mention in financial statements and balance sheets. Take Educomp, a company with huge assets, not easily replicable, in terms of education content, which it developed over several years of research and efforts. The company got listed in January 2006 at Rs 155 a share and the market believed the stock was expensive, at about 30 times its earnings. But, ultimately, that content or intellectual property, not listed anywhere, paid off and company sales jumped almost 20 times in the past four years. Post its listing, the stock has given huge returns of 2,500 per cent. In such cases, as an investor, one should not just look at the P/E ratio or P/BV but also consider the size of such assets. Also, if possible, the advantage the company has because of such assets and benefits in monetary terms.
R&D AND ADVERTISING
Likewise, the Research & Development (R&D) expenditure on a particular product is likely to be reported in the profit and loss account as an expense item. However, the actual benefit arising out of the R&D effort, in the form of an ‘molecule’ in case of a pharma company or patents or rights will not be visible directly in the balance sheet. Instead, one may have to look at sales figures to gauge the benefits from the molecule’s development. For example, Sun Pharma Advanced Research Company (SPARC), engaged in R&D of pharmaceutical products, has market capitalisation of Rs 2,074 crore. This is huge, compared to its sales of just Rs 35.14 crore and a net loss of Rs 91.4 lakh in 2008-09. For, the market values its ongoing R&D efforts for developing several molecules for different drugs,some of which are at an advance stage of getting to be patented.
Like SPARC, many companies are doing R&D, but it is hard to asses the benefits till the time of actual implementation and conversion into sales. But, investors should go through the kind of investments involved, stages of development and opportunities in targeted R&D effort. A unique innovation, along with patents, could make all the change. Investors can check the details of such R&D effort and stages of implementations in the directors' statement in the annual reports and investors' presentations provided by the company. Directors also give their assessment of the opportunity in a particular segment.
Cipla’s R&D efforts led to development of its well-known emergency contraceptive drug brand, i-Pill, now sold to Piramal Healthcare for Rs 95 crore. But, the company not only spent on R&D for this product but also undertook huge advertising. The benefits of these are not shown in the books but they pay off some time in the future. Companies make initial advertising efforts to develop the long-term market for the product and to increase the awareness. The benefits of such assets are not visible many times to investors, but it makes a lot of difference and leads to higher revenues. Investors can look for such figures and try to assess what kind of benefit it will have. Also, how much boost it could provide to revenue and profits.
BRAND NAMES
Intangible assets such as brand value are equally important but do not find any mention in the books. For instance, Maruti Suzuki India, Hero Honda, Hindustan Unilever and some of the known Indian brands have been able to drive their growth due to the recognition/respect for their brands. Brands also help investors in differentiating companies in the same industry. If the company has a known brand, it will definitely have an edge over its counterpart in terms of higher sales and even, some times, better margins. L&T, India's largest private sector engineering company, earns a lot of sales mileage and better margins because of its brand name. Usually, as investors, we do not give much weights to the brand name, until the time they are either sold. For example, Zicom, a leading brand in security products, recently sold this business to Schneider for a consideration of Rs 225 crore.
The company sold this business on a premium because the total sum paid also includes the royalty to use the Zicom brand for three years. For investors, a known brand means an edge over others, competitive advantage, some protection against competition and predictable sales growth. Also, if a company is not having brands, the products are not differentiable, which could lead to price wars and even full erosion in sales.