Monday, February 17, 2014

The Brand: You May Not See It In The Accounting Statement, But It's There


“If this business were split up, I would give you the land
and bricks and mortar, and I would take the brands and
trade marks, and I would fare better than you.”
John Stuart, Chairman of Quaker (ca. 1900)

 
The quote above opens the article “Brand Valuation” by Jan Lindemann.  The comments of Mr. Stuart are probably even more relevant in today’s world, if that’s even possible.  Brands are everywhere.  They are no longer just about products or the companies that make products.  These days cities, states, and even countries (watch Bloomberg for the ads about investing in Kazakhstan, Mongolia, and Belize) are aware of their brand.  Athletes, singers, movie stars, and politicians probably pay closer attention to their brands than many companies.   Today, even types of meat have brands (beef “It’s what’s for dinner” and pork “The other white meat”).
While their influence on consumers is undeniable, I don’t think brands belong on the balance sheet as an asset.  A brand is an intangible asset.  By definition something that’s intangible can’t really be measured.  Lindemann tries to make the case that through financial and other analysis one can put a price on the value of a brand.  His process calls for a lot of forecasting and subjective calculations.  As it turns out, forecasting is incredibly difficult.  Study any forecasts made at the beginning of each year about the economy, sports, or world politics and you’ll find a dismal record, even by the so-called experts.    

The subjective part of the recommended analysis may be even more flawed.  Coach, for example, is a luxury brand whose stock has fallen a bit over the last couple of years because of competition but also because consumers have come to view it as a little less aspirational.  The company still sports some of the highest margins around throws off a lot of cash, but does management actually consider the brand worth less?  I can’t answer that for sure, but the evidence certainly points to the consumer as being less enthused about the brand.  Consider the ratings agencies of S&P, Moody, and Fitch.  They were simply trying to rank the safety of securitized mortgages, a proposition that requires far less accuracy than specifying a particular value.  Whether by incompetence or misconduct, they failed miserably.  
Finally, the accounting scandals in recent years of Enron, WorldCom, and Tyco are example of how companies were able to fudge real and measurable numbers.  Allowing companies to value their brand for placement on the accounting statements would be asking for fraud. 

Today’s accounting standards allow a company to record as goodwill the amount of purchase over book value of another company.  The purchasing company is then supposed to test for impairment each year.  I asked my accounting instructor how to test for impairment in a recent lecture.  His response was, “I don’t know and I’m not even sure it’s possible.”
In the end, a brand is just a symbol of the reputation of a company or product.  Just as with a reputation, it may take several years to build up a brand, but only a moment for it to be tarnished.  For several years my family and I would always stay with Hyatt when we travelled.  Building up a large number of points I tried to redeem them for a free night in Paris last summer.  When they told me I would need to book a second room because there were three of us, I wrote to the president of the European operations.  I got a nice letter back from the manager of the Paris property apologizing, but basically telling me rules are rules.  I am now a member of the Marriott rewards program.

I think the value of the brand is reflected in the income statement and the return on capital by the firm.  It is the value of the brand that leads to high sales and large margins.  I recently wrote about the world’s most ubiquitous brand, Coca-Cola.  The Coke brand is invaluable, which is part of the reason why investors are always willing to pay a higher multiple to own the stock.

P.S.
The article, written in 2004, uses Ford as an example of a company focusing on intangible assets and investing $12 billion in brands such as Jaguar, Volvo, Aston Martin, and Land Rover.  See how that turned out:  Just How Much Did Ford Lose on Jaguar and Land Rover

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