intangibles

intangibles - 1 Valuing Companies with intangible assets...

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Unformatted text preview: 1 Valuing Companies with intangible assets September 2009 Aswath Damodaran Stern School of Business adamodar@stern.nyu.edu 2 Valuing Companies with intangible assets As we move from manufacturing to service based economies, an increasing large proportion of the firms that we value derive their value from intangible assets ranging from technological patents to human capital. In this paper, we focus on a few variables that make valuing these service companies different from conventional manufacturing firms. The first is that accountants routinely miscategorize operating and capital expenses, when firms invest in intangible assets. Thus, R&D expenses, which are really capital expenses, are treated as operating expenses, thus skewing both reported profit and capital values. The second is that firms with intangible assets are more likely to use options and restricted stock to compensate employees and the accounting treatment of this compensation can also affect earnings and cash flows. In this paper, we look at how best to correct for the accounting errors and the consequences for valuation. 3 In the last twenty years, we have seen a shift away from manufacturing firms to service and technology firms in the global economy, with the magnitude of the change greatest in the United States. As we value more and more pharmaceutical, technology and service companies, we are faced with two realities. The first is that the assets of these firms are often intangible and invisible patents, know-how and human capital. The second is that the way in which accounting has dealt with investments in these assets is inconsistent with its treatment of investments in tangible assets at manufacturing firms. As a result, many of the basic inputs that we use in valuation earnings, cash flows and return on capital are contaminated. In this paper, we begin by looking at the characteristics shared by firms with intangible assets and the valuation issues that follow. We then look at the dark side of valuation, as it manifests itself in these companies, and some remedies. In particular, we focus on two issues: the corrections for accounting inconsistencies in these firms and the how best to deal with the fact that many of these firms are also heavy users of employee options as compensation. Firms with intangible assets Looking at publicly traded firms, it is obvious that many firms derive the bulk of their value from intangible assets. From consumer product companies, dependent upon brand names, to pharmaceutical companies, with blockbuster drugs protected by patent, to technology companies that draw on their skilled technicians and know-how, these firms range the spectrum. In this section, we will begin by looking at their place in the market and how it has shifted over time and follow up by identifying characteristics that they share....
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This note was uploaded on 12/01/2011 for the course FINANCE 350 taught by Professor Aswath during the Summer '10 term at NYU.

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intangibles - 1 Valuing Companies with intangible assets...

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