An article in CFA Institute argues that intangible assets (non-physical assets such as trademarks, patents, etc.) are “increasingly critical to corporate value, yet current accounting standards make it difficult to capture them in financial statements.”
As investment in intangible assets has grown (the article reports that it now represents 33.4% of total U.S. gross domestic investment in 2018), “the value of those assets as drivers of enterprise value becomes ever more essential.”
The article outlines five common methodologies that “build on historical and prospective financial information within the framework of current accounting standards” and explains how they can be used to ascertain a firm’s competitive standing:
- Relief from Royalty Method (RRM)— is based on the hypothetical royalty payments that would be saved by owning the asset rather than licensing it. This method is often used to value intangibles that can be tied to a specific revenue stream and where “data on royalty and license fees from other market transactions are available.”
- Multiperiod Excess Earnings Method (MPEEM)– -is a “variation of discounted cash-flow analysis.” MPEEM isolates those cash flows associated with a single intangible asset and measures fair value by discounting them to present value. This method is used primarily when one asset is the primary driver of a firm’s value.
- With and Without Method (WWM)—estimates an intangible asset’s value by calculating the difference between two discounted cash-flow models: one based on the “status quo” for the business with the asset, and the other without it. This method is often used to value noncompete agreements.
- Real Option Pricing—is used mostly for assets that have the potential to generate cash flow in the future but are not doing so now, such as undeveloped patents and/or undeveloped natural resource options. “As with stock options,” the article notes, “a key challenge in the valuation of real options is assessing the underlying volatility.”
- Replacement Cost Method Less Obsolescence—requires an assessment of the replacement cost for the intangible asset, which is then adjusted for an obsolescence factor relative to the intangible asset.
The following chart summarized the models:
The article concludes: “In today’s economy, the value provided by intangible assets must be captured in enterprise valuation. Analysts have to expand the range of data sources and techniques they use in valuation and develop methodologies that are suitable to the intangible asset being valued for more reliable valuation results.”
