A global investor perspective

Posted
29 June, 2015

Cars, investments and intangible assets

What matters to the modern day car buyer? According to consumer surveys, style and appearance rank highly but the most important factors are reliability, price, running costs, fuel efficiency and safety.  New cars incorporate technology such as lane departure warning systems, automatic parking, integrated communication and stop start capabilities. In April, a driverless car completed the journey from San Francisco to New York, virtually unaided by human intervention.

The critical element here is software; millions of lines of code that we can’t touch or see – an intangible asset.  Leading automotive component manufacturers such as Continental, Delphi, Denso and Panasonic have transformed the shape of their workforce, employing thousands of software engineers.  For today’s buyer it’s not so much about the visibly obvious characteristics of the vehicle but the less tangible attributes.  The same applies in investment.

Investors clearly pay attention to the value of intangible assets, whether these are software, brands, patents, customer loyalty, scale, creative talent, market position and management capabilities.  The vast majority of companies trade at a significant premium to the value of their tangible assets.  What do fund managers and analysts want from financial reporting to help them better appreciate the potential of modern corporations?

What most don’t want is for accountants to try to value businesses themselves by placing a fair value for intangibles on the balance sheet. Where this has found its way into financial statements, specifically in M&A accounting, it’s not clear that this has helped investors. It’s the role of capital markets to value companies, not accountants.

Words and numbers

Telling the story of a company – its performance and prospects, the opportunities and risks that it faces -takes more than mere words and numbers on the page.  Investors strive to get beneath the reported accounting returns.  We want to understand the underlying economics of the business and its potential to generate cash flows over the long term.  In the best financial reporting, the narrative and the numbers work together to inform. Inevitably, words have a bigger role to play in describing the prospects for the business.  Integration, however, is key – even at the most basic level.  It is immensely frustrating for the narrative to highlight specific data items, such as capital expenditure, that bear no relation to figures in the financial statements.

Lengthy prose is best avoided.  Management teams that have a coherent strategy are often best placed to tell their story in a concise fashion.  Sometimes it feels as through pages and pages of words is more of a reflection of an absence of strategy.  Hearts sink at the prospect of wading through reams of tightly spaced text.  Worse still, when it’s presented in narrow columns or a grey font on a blue background.  Perhaps I should succumb to spectacles but give me nicely spaced text across the page on a white background any day.

I have grown to appreciate the plain formatting of US 10K documents.  As a global investor I have the opportunity to review financial reporting across many jurisdictions.  While I used to loath 10Ks I now welcome them.  In some respects these are extraordinary prescriptive – bizarrely, note 4 is always the mine safety disclosure. But equally there is sufficient flexibility for companies who want to tell their story to do so in an integrated manner using headings such as Business Model, Strategy, Market Structure, Competitive Advantages and Risks.

Investor focus

So what would help investors as integrated reporting continues to evolve?  First, we shouldn’t neglect the numbers.  High quality accounting is critical to an integrated approach and there is more work to be done by standard setters, specifically around the reporting of cash flows and the amortization of intangibles.  Greater clarity in remuneration reporting would be appreciated, while keeping narrative report concise and focused on material issues is also essential. Investors welcome innovation in reporting, but preparers should be wary of slipping into gimmickry.

Today there is a wide spectrum with some excellent reporting within the existing formats while others do no more than meet the minimum regulatory requirement.  And, of course, this in itself has information value for investors.

 

Nick Anderson is Co-Manager of Henderson’s Global Sustainability Funds and Head of Equity Research