Current Stock Valuations Missing $3.4 Trillion in Hidden Assets

A recent Bloomberg article highlights how old accounting rules and metrics are effectively “broken” and creating distortions that are making some company fundamentals look worse than they really are.

The article quotes New York University finance professor Baruch Lev (whose 2017 paper sparked a debate about valuation methods): “You get numbers which are highly inflated for some companies and are understated for other companies. It doesn’t make any sense.”

While some might see this as a way to rationalize the market’s lofty stock prices, proponents say it makes sense since some accounting standards—originally developed for shipbuilders and oil drillers—are “bound to lose relevance.” According to the article, “Practitioners now regularly adjust models to give greater heft to things that were previously thought too abstract to value.” It cites data from fund manager Knowledge Leaders Capital LLC who says it sees $3.4 trillion extra book value on the balance sheets of the roughly 3,000 stocks it studies—causing the price-to-book ratio to fall by 14 percent.

“Not recognizing intangible assets can push down both profits and book value in businesses that depend on research and marketing,” the article says, “which are increasingly important in the global knowledge economy.”

According to Travis Fairchild, a fund manager at O’Shaughnessy Asset Management, “You’ve got all these assets that don’t show any value in their financial statements that are just becoming more and more valuable in today’s society. We’ve moved from an industrial marketplace to much more of a technology and intangible asset industry, and that’s just creating larger and larger distortions.”

But intangibles can be hard to value, says Angelo Meda of Banor SIM SpA, and trying to account for them can become an excuse to justify buying pricey tech stocks Metrics like book value, he adds, can remain useful for the financial and industrial sectors.  Research Affiliates’ Vitali Kalesnik weighs in: “Investors need to be quite conservative not to try to be too cute or too creative in trying to value each individual company in a way that supports their idiosyncratic thinking.”