Firms Now 5/6 Dark Matter!

Scott Sumner:

We all know that the capital-intensive businesses of yesteryear like GM and US steel are an increasingly small share of the US economy. But until I saw this post by Justin Fox I had no idea how dramatic the transformation had been since 1975:


Wow. I had no idea as well. As someone who teaches graduate industrial organization, I can tell you this is HUGE. And I’ve been pondering it for the week since Scott posted the above.

Let me restate the key fact. The S&P 500 are five hundred big public firms listed on US exchanges. Imagine that you wanted to create a new firm to compete with one of these big established firms. So you wanted to duplicate that firm’s products, employees, buildings, machines, land, trucks, etc. You’d hire away some key employees and copy their business process, at least as much as you could see and were legally allowed to copy.

Forty years ago the cost to copy such a firm was about 5/6 of the total stock price of that firm. So 1/6 of that stock price represented the value of things you couldn’t easily copy, like patents, customer goodwill, employee goodwill, regulator favoritism, and hard to see features of company methods and culture. Today it costs only 1/6 of the stock price to copy all a firm’s visible items and features that you can legally copy. So today the other 5/6 of the stock price represents the value of all those things you can’t copy.

So in forty years we’ve gone from a world where it was easy to see most of what made the biggest public firms valuable, to a world where most of that value is invisible. From 1/6 dark matter to 5/6 dark matter. What can possibly have changed so much in less than four decades? Some possibilities:

Error – Anytime you focus on the most surprising number you’ve seen in a long time, you gotta wonder if you’ve selected for an error. Maybe they’ve really screwed up this calculation.

Selection – Maybe big firms used to own factories, trucks etc., but now they hire smaller and foreign firms that own those things. So if we looked at all the firms we’d see a much smaller change in intangibles. One check: over half of Wilshire 5000 firm value is also intangible.

Methods – Maybe firms previously used simple generic methods that were easy for outsiders to copy, but today firms are full of specialized methods and culture that outsiders can’t copy because insiders don’t even see or understand them very well. Maybe, but forty years ago firm methods sure seemed plenty varied and complex.

Innovation – Maybe firms are today far more innovative, with products and services that embody more special local insights, and that change faster, preventing others from profiting by copying. But this should increase growth rates, which we don’t see. And product cycles don’t seem to be faster. Total US R&D spending hasn’t changed much as a GDP fraction, though private spending is up by less than a factor of two, and public spending is down.

Patents – Maybe innovation isn’t up, but patent law now favors patent holders more, helping incumbents to better keep out competitors. Patents granted per year in US have risen from 77K in 1975 to 326K in 2014. But Patent law isn’t obviously so much more favorable. Some even say it has weakened a lot in the last fifteen years.

Regulation – Maybe regulation favoring incumbents is far stronger today. But 1975 wasn’t exact a low regulation nirvana. Could regulation really have changed so much?

Employees – Maybe employees used to jump easily from firm to firm, but are now stuck at firms because of health benefits, etc. So firms gain from being able to pay stuck employees due to less competition for them. But in fact average and median employee tenure is down since 1975.

Advertising – Maybe more ads have created more customer loyalty. But ad spending hasn’t changed much as fraction of GDP. Could ads really be that much more effective? And if they were, wouldn’t firms be spending more on them?

Brands – Maybe when we are richer we care more about the identity that products project, and so are willing to pay more for brands with favorable images. And maybe it takes a long time to make a new favorable brand image. But does it really take that long? And brand loyalty seems to actually be down.

Monopoly – Maybe product variety has increased so much that firm products are worse substitutes, giving firms more market power. But I’m not aware that any standard measures of market concentration (such as HHI) have increased a lot over this period.

Alas, I don’t see a clear answer here. The effect that we are trying to explain is so big that we’ll need a huge cause to drive it. Yes it might have several causes, but each will then have to be big. So something really big is going on. And whatever it is, it is big enough to drive many other trends that people have been puzzling over.

Added 5p: This graph gives the figure for every year from ’73 to ’07.

Added 8p: This post shows debt/equity of S&P500 firms increasing from ~28% to ~42% from ’75 to ’15 . This can explain only a small part of the increase in intangible assets. Adding debt to tangibles in the numerator and denominator gives intangibles going from 13% in ’75 to 59% in ’15.

Added 8a 6Apr: Tyler Cowen emphasizes that accountants underestimate the market value of ordinary capital like equipment, but he neither gives (nor points to) an estimate of the typical size of that effect.

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  • Mars

    The answer is error. The graph was calculated by subtracting reported tangible asset value from share price and diving by share price. Share price does not equal tangible asset value plus intangible asset value. Also, Ocean Tomo is an investment company specializing in intangible assets.

    • Whats missing in the equation Total = Tangible + Intangible ?

      • sflicht

        I think he’s making the point that market cap is not in general equal to ownership equity (i.e. book) value = tangible + intangible – liabilities.

      • 3rdMoment

        One thing that’s missing is increase in debt levels. Part of what’s going on is that more of the total value of the firms in the index is “owned” by bondholders rather than stockholders.

        If you redo the calculation using something like total tangible assets divided by enterprise value, you will get a much less extreme trend (but still a trend). Another option is to divide total tangible assets by total sales, again you get a downward trend.

        I blogged about this trend here.

        Thinking about this over the last week, I’ve come to believe that debt is a bigger part of the story than I had realized. (But still not the whole story.)

      • I can’t seem to find data showing how the average debt to equity ratio has changed over time in the S&P500.

      • 3rdMoment

        Agree it’s hard to find. I’ve been playing with some Compustat data trying to figure out better what’s going on.

        Looks to me like debt/equity (and more importantly debt/tangible equity) has increased a lot since the 1970s and 1980s. Other measures like debt/sales has increased as well. This explains a part of the very large changes shown in the figures.

        On the other hand, leverage hasn’t really increased over the last two decades, it’s even fallen since the crisis. But the changes shown in the figure are relatively small over that period, and can be partially explained by P/E changes. I so believe there is a real trend towards intangibles, but not as drastic as you would think from the figure.

        An image search on “S&P 500 leverage” turns up some interesting results, including this for industrial firms:

        Or this one, which appears to be for all US corporations:

      • 3rdMoment

        Also, as I said in my blog post linked above, around a quarter of the firms in the S&P 500 actually have *negative* tangible book value. This is possible because these firms have significant debt. But it means that, using the measure shown in the figure, you would conclude that *more* than 100% of the value of these firms comes from intangibles.

        By contrast, firms like Google and Facebook, with little or no debt, are around average using the measure shown in the figure. This should probably lead you to question whether it is the right measure.

      • sflicht

        So what exactly do you suggest as a better metric for “dark matter’ in the economy? I’m willing to believe there are much better variables to look at than tangible equity / price. So what is your proposal?

      • 3rdMoment

        Well, one idea is something more like tangible assets/enterprise value. Essentially adding debt back on to both the numerator and the denominator. By my calculations this also shows a decline over time, but not nearly as strong, and at least some of the trend is due to changes in stock valuation levels.

      • sflicht

        Should one really ignore Modigliani-Miller? In some sense the debt-to-equity ratio should be irrelevant. If it’s not, some story about why is probably necessary.

      • 3rdMoment

        I’m not ignoring Modigliani Miller, I’m pointing out that the measure used in the figure is not invariant to financing, even when Modigliani Miller holds.

        Start with a firm with no debt, with an economic value of $100 and a tangible book value of only $50. The firms stock should also be worth $100. Then by the measure presented, 50% of the market value is intangible. Now the firm borrows $50 and uses it to buy back half the shares. The total value of the firm is still $100 (under MM assumptions), $50 of debt and $50 of stock. But now the tangible book value of equity is zero. By the measure presented here, the firm looks 100% intangible!

      • I added to the post some data on debt/equity. It has changed, but not enough to explain most of the intangible effect.

      • 3rdMoment

        Good find. See my most recent comment for my new calculations, which are perhaps even more favorable to your position!

      • Mars

        The graph is basically another way of showing this:

        Notice where the dates in the OT graph fit on Shiller P/E graph.

        I don’t think it makes sense to say that volatility in the Shiller P/E graph were driven by changes in “intangible assets.”

        This is not to say that there isn’t some trend toward intangible assets becoming a larger share of corporate assets. It just is not likely this large. The discount rate seems to be a much more plausible factor here.

      • No, price/earnings is not at all the same. Price/book is much closer.

      • Peter McCluskey

        With the benefit of hindsight we can see that share prices were mistakenly low in 1975. Using 1968 as a start point would show a less dramatic change. Using the accounting measure of intangible value would eliminate most of the investor mistakes, but would also omit much genuine intangible value. I don’t expect any measure of intangibles to be very good.

      • Data showing that this key %intangible figure was typically much higher before ’75 would be reassuring. But I haven’t yet found any such data.

  • sflicht

    I would add some hypotheses.

    (1) Perhaps there have been important changes to the laws or standard practices regarding how companies do their accounting.

    (2) The definition of tangible assets (as defined according to accounting law) maybe doesn’t coincide well with your intuition about what should count as “non-dark matter” assets. I’m sure there’s some overlap, but it might be less than we think.

    (3) This could just be an accounting identity after taking into account “well-understood” (or at least frequently commented upon) changes in the economy, like an increase in the services sector and offshoring of manufacturing. If most modern American businesses create value by using people and software to design specs for and effectively manage widget production businesses in other countries (think of companies like Apple), then all the American business value is necessarily is the software, designs, and management practices, which must all count as intangible. So the dark matter is just an accounting consequence of important changes in the economy, and not surprising per se.

    (4) Related to your innovation point, a lot of innovation has been in creating new business models to leverage intangible assets, and financial mechanisms to enable this leverage. The most famous restaurateur in the 1960s had a brand with some intangible value, but the concept of “celebrity chef” did not exist then; Gordon Ramsay’s brand is probably the single most valuable asset his company owns. Actually their most valuable asset may be his business model for building and leveraging that brand, but I doubt that model is explicitly valued on their balance sheet, while the brand itself probably is. When intangible assets show up more on balance sheets, it just means that companies are leveraging them more by borrowing against them. It might not have occurred to the 1960s restaurateur to attempt to borrow money against her valuable brand, and her bankers might not have been able to trust her valuation of that brand. So according to this hypothesis, the real 40-year change is improvements in management skill and perhaps financial infrastructure which caused previously hidden dark matter to show up on balance sheets.

    A useful step in untangling the competing hypotheses would be to look at cross-section international data, as well as data broken down by industry.

    • IMASBA

      Those hypotheses make sense. We should indeed never forget that these are accounting identities: artificial categories that don’t correspond to reality. Western corporations have offshored manufacturing capital, the services sector has expanded and labeling stuff as intellectual property is a common tax avoidance strategy (through Ireland).

      • sflicht

        It could be a good thing.

      • IMASBA

        I just made the observation that the simple explanations you listed are actually quite good explanations.

  • Eliezer Yudkowsky

    Suppose that it had become effectively harder to reach customers; that customers were more reluctant to switch between suppliers; that more total volume buying decisions were made by more conservative bureaucrats; or that buying volume was for products with relatively few suppliers who were able to form effective cartels.

    Consider, e.g., the airlines that, without any explicit collusion, use algorithms to try shifting their prices upward by a dollar and see if their competitors on the same route also ‘agree’ to shift upward by a dollar; or that try a price drop of a dollar to see if the price drop is followed, and then if so, raise the price again.

    Then there’ll be non-competed-away price premiums, which means that more relative value is being generated by ‘capturing’ the customer. By means other than, say, manufacturing a cheaper product. In other words, success isn’t about what product you manufacture (it’s mostly identical to others and is produced by similar means) or even about price competition (that would collapse the premia associated with individual customers), but about getting very valuable customers to trade with you rather than someone else.

    Or consider the consistent price premiums of real estate agents or venture capitalists; these are industries where the whole trick is getting people to trade with you rather than someone else, because the industry has a persistent excess premium that makes it easy as falling off a log to profit once people are trading with you. (Another result is a lot of excess entry or attempted entry.)

    If that’s somehow happening across the economy, then more assets might be the intangible tendency of people to trade with you rather than someone else, or the inertia of existing customers who go on trading with you. The corresponding prediction would be a great increase in the marginal revenue per customer exclusive of marketing expenses, across the economy. In other words, the prediction is that relative to earlier times, you’d see that adding a new customer for free (without any marketing being required) would generate a much larger percentage profit than it would in the 1970s or in a company with less intangible assets.

    Such a phenomenon probably isn’t enough to account for such a huge shift, but it could be part of the story. If so it’s bad news; more customer inertia or more money spent fighting to acquire excess premia from customers doesn’t seem like a good thing.

    Also, I agree that HOLY CRAP.

    • I agree that firms having more market power with customers gives them more profits. And if they do this not via on-the-books capital they it looks like intangible capital. The question is *how* could they have more market power with customers. I mentioned brand loyalty and rapid innovation as two possibilities. Do airlines or real estate agents actually have more market power than they used to, and if so where did that change come from?

      • Eliezer Yudkowsky

        Airlines have more market power via antitrust-evading coordination, as I mentioned above; they use pricing algorithms that enforce cooperation in a distributed way via their behavior, e.g. automatically dropping the price on one route if a rival tries to do so, thereby eliminating any expected gain from price drops. I’m not sure how far this extends beyond just airlines, though. More purchasing decisions being made bureaucratically seems like a more plausible general explanation.

        Maybe check if B2B or B2Government companies have far more ‘intangible’ assets than businesses that sell household items to individual consumers, for a start – that would catch some broad classes of possibility.

      • My impression is that airfares are lower than they used to be, and airlines don’t tend to be all that profitable. Yglesias writes about that here.

    • Eliezer Yudkowsky

      Alternate hypothesis: Globalization. To the extent that a firm’s real competitive advantage on the world market consists of being located in a developed country, maybe that’s an intangible asset? Does that make any sense?

      • We could check that hypothesis by comparing the intangible fraction for firms that are more global.

  • TheBrett

    Financialization, maybe? Traditional big firms putting investment money into lucrative financial products, or operating finance divisions alongside their traditional production (like the finance arms/banks of the auto companies). I know Sony’s financial arm was very valuable in holding up the conglomerate’s overall finances.

    Not sure that explains more than part of it, though. GM Financial is a pretty big share of GM’s overall assets, but only about 27%.

    • Financialization means that firms must make themselves as attractive as possible to a small number of investment banks. Resources are displaced from production to signaling. Financialization drives many trends.

      Why financialization? Declining profit rates and technological stagnation. It started with the end of the postwar boom in the early 70s.

    • 3rdMoment

      I’m not sure what the overall effect of “financialization” is, but you should note that by the measure shown in the figure, banks look much *more* “tangible” than average. Banks have a much higher tangible-book-value to market-cap ratio than most other industries.

      The firms that have strongly negative tangible book values (and hence come out looking the most “intangible” by the measure here) tend to be communications firms like Verizon or Time Warner Cable.

  • Patent protection getting weaker over the last fifteen years doesn’t seem too inconsistent with the smallest gap in graphs being between 2015 and 2005. The big jump is between 1985 and 1995. But I don’t know if patents are common enough across industries to explain such a huge shift.

  • Doesn’t “intangibles” roughly coincide with rent-seeking opportunities?

    If so, isn’t this a symptom of parasitism? [It does coincide with the financialization of the economy.]

  • Chalid

    Have you looked at to what extent this holds if you hold the industry constant? Do e.g. auto companies, or airlines, have a much higher ratio of market cap to tangible assets than they did in 1975?

    • 3rdMoment

      First, note that the numerator is no “tangible assets,” it’s “tangible book value,” which is tangible assets minus liabilities.

      And yes, by my calculations the trend shown in the figure is strong across most industries, including automobiles firms and transportation firms.

      • Chalid


        Would it be easy to calculate what the S&P’s intangible assets/market cap would be now, if the industry weights had stayed constant? Alternately, what would it be industry weights had changed but tangible book value ratio within each industry had stayed constant?

  • Eliezer Yudkowsky

    Additional thought: if firms hold stock in each other, then the true degree of intangibility is even greater. I.e., if Goldman Sachs is holding a billion dollars of Apple stock, that will show up as a billion-dollar tangible asset for Goldman even if the Apple stock itself is mostly intangible assets. (Do I have that right?)

    • That sounds like the sort of thing it should be easy to check on if it is happening.

  • Pingback: TheMoneyIllusion » Ryan Avent on Secular Stagnation()

  • Personzorz

    Isn’t this just an indication that the material economy has stopped expanding and we need to substitute all kinds of notional wealth

    that can vanish in a puff of logic to pretend the economy is still expanding?

  • I think it’s network effects. I’d bet it maps very very near to Greenspan’s measure of the shrinking on tonnage weight of GDP each year. A lighter weight higher quality thing is harder to copy and organize foreign suppliers for… bc he who buys most pays least.

    • Vitalik Buterin

      Bingo. Modern companies basically work by building moats protected by nothing but hard coordination problems. In most cases, the capital is the set of smart employees with good ideas that are good at working together with each other plus the set of external connections and reputation, and the hard coordination problem is that of getting all of these people to move over to another company at the same time.

      • Can find concrete measures of the degree to which firms are protected by coordination problems, so we can look at the history of that to test this theory?

      • Vitalik Buterin

        Hmm. Measuring coordination problems is hard; if you had asked me to come up with a measure ex ante I may well have simply come up with your dark matter rate. But my theory would imply some predictions:

        1. Attempts to poach employees, as well as attempts among employers to coordinate against employee poaching, should increase, incluidng through legal means
        2. Higher employee compensation for knowledge workers due to efficiency-wage arguments
        3. Increased spending on advertising and on activities related to making connections
        4. Reduced level of attention on securing other forms of capital

        (1) is clearly there; see the recent Google/Apple antitrust hubbub as well as the prevalence of non-compete clauses; (2) seems there as does (3), and (4) can be seen from software companies’ willingness to open source an increasing number of core products. But I don’t know enough about history to determine if those are actually increases from 40 years ago or if they were always there to a similar extent.

      • I don’t think you can test history vs. today accurately after digital happens. I think 100% of Sec Stag hypo is wrong. I think it is entirely Digital Deflation. I don’t think there is anywhere left for capital to go. I think this is incredibly hard for economists to accept / grok.

        Colleges end. $200K in edu for free online. Offices end. No more commercial paper. Personal cars end for most. no more car loans. Manufacturing ends. IP is freely copied and 3D printing means everything physical is $1 per pound. VR happens and nobody poor wants to leave their small shabby room where they are rich surrounded by naked women and fighting dragons.

        This shift is so basic, it fundamentally rewrites the basic tenets of economic scarcity, if there is a replacement good for EVERYTHING that is BETTER than the old atomic thing.

        The thing is, when you tell a some Phd economist that people will freely choose to consume only electrons and calories in order to be DONE with economic scarcity, econos don’t say “well then I won’t be needed.”

        Econos can’t fathom that their science is dependent on a man not becoming god. Surely they must still matter!

        It’s the same when you ask econos what happens to macro is there is only one global currency and no central authority – they can’t say “well then I won’t matter.”

        Even though that is clearly the case.

      • Ronfar

        Time will still be a scarce resource, even in a world of effectively infinite material abundance…

      • This is WHY I keep waiting for Robert Hanson to come out in support of Uber for Welfare until we get to VR as main form of reality:

      • Swami Cat

        Morgan is expressing my thoughts on the matter as well (better than I could). I see us as entering a world of free and virtual, where economics no longer applies– at least not in the same way.

        Just about everything I do is free and/or virtual. Every year I do more free or near free (and it gets better) and spend less on physical things.

        Two examples: twenty years ago my company built a teleconference room in every region. The cost was about a third of a million plus a hundred grand or so annually in upkeep and maintenance. This was to eliminate the costs of air travel. Today I have a better teleconference system included as a free app on every smart device in my house. I have millions of dollars in teleconferencing utility and it shows up as near zero in economics measures. It subtracted from GDP!

        Second, I used to buy an album or two a month at $8 or $9 each in the late seventies. Today for $15 a month I get a virtual library in CD quality which includes over twenty million albums. Better quality, portable and more convenient. This would have cost millions to buy and store twenty years ago. Today, better for less.

        Economists are simply missing what is going on right under their feet. Stagnation my ass.

      • nickgogerty

        if You are interested in moats and innovation you may like it explains economics and innovation using evolutionary theory. I teach some of it at Columbia University’s MBA program.

    • Joe Leider

      I’d bet on network effect as well. The world seems a lot more winner takes all. It doesn’t make sense to have two Google’s, two Facebook’s, two Linkedin’s or even two Microsoft’s. The network of software or social media or search engine users means that everyone ends up using the same product. But that product can be overturned quite quickly by the new, better product.

  • Robert Koslover

    Might selection be indeed the factor? After all, almost nobody made any money from software in 1975. And computers were just getting started. Now Apple, Microsoft, Google, Facebook, etc. are among the biggest companies in the world. And almost none of their assets are tangible, right? In other words, this is all because we have transitioned from the “space age” (1960s-70s) to the “information age” (1990s-present). (Caveat: Please excuse me if I have completely misunderstood this post, as I’m neither an economist nor an accountant.)

    • Robert Koslover

      Added: I now see that Paragraph (3) in the comment by sflicht seems to have already covered what I was trying to say. So for what it’s worth, I agree with him on that point.

  • Ben

    One contributing factor is a shift in the mix of the S&P over time towards technology firms. R&D spending is typically expensed in US GAAP (ie accounting rules). To me it’s still business investment in an asset (code vs equipment) but it wouldn’t be picked up in tangible assets.

    Another accounting driven factor could be fixed asset depreciation. Remember that in accounting, fixed asset values are based on historical purchase price depreciated over time, not fair market value. A firm may have large investment early in its life (build the factory) that is not repeated. Inflation will also impact the ratio over time as fair market values (market cap) rise while book values are static, excluding depreciation. Has the average age of an S&P firm increased over this period?

    • See 3rdMoment below on the trend being across industries. If so, trend can’t be much explained by change in industry mix.

  • Ray Lopez

    Thought provoking post. It could be this is sign of calcification of the economy, due to preservation of the status quo, as would happen over time with Keynesian economics (which preserves the status quo). US bankruptcy laws that don’t allow any firms to fail is also a suspect. And trademarks grow more valuable over time (as does know-how) so this is a factor as well. Patent walls also are a potential culprit. It’s also possible that this dark matter in valuation is benign.

    • The post-1970 trend corresponds to the abandonment of Keynesian policies.

      • What Keynesian policies were abandoned? The draft?

      • Keynesianism dictates that governments (central and local) should resist the impulse to impose austerity during downturns.

      • And what evidence do you have that that was ever implemented before Nixon and ever “abandoned” after him?

      • I suppose the sharpest contrast is between the New Deal’s public-works projects and contemporary deep cuts in employment by governments.

      • The New Deal wasn’t explicitly Keynesian; it resulted in a permanent expansion in the size of government. That’s not how Keynesian stimulus is supposed to work. The increase in government employment as a percentage if civilian employment in the U.S. from 1948 to 1975 was secular, not cyclical.

        Disqus Home

  • Eliot

    Or perhaps it is accumulated “goodwill”, that is, the balance sheet accumulation of acquisition premiums paid by a given firm for other firms it acquires over time.

    • And why didn’t firms have goodwill in 1975?

      • Tatil_S

        You cannot add goodwill to your own company, only an acquirer that pays above the cost of tangible assets can add that to “explain” the difference in the balance sheet. We’ve had a lot more time since ’75 to accumulate series of acquisitions.

      • 3rdMoment

        Goodwill is not part of tangible assets, so it does not affect the measure shown in the figure, which is tangible book value of equity divided by market cap.

        Goodwill is the largest component of the subset of “intangibles” listed on the balance sheet, though. So the growth of goodwill largely explains the growing difference between regular book value and tangible book value.

  • Foo McBarson

    What if the stock market has simply become a more popular place to invest money, driving the market capitalization of companies up? (Either through increased investment overall or differently balanced investment, e.g. fewer people buying treasury bills or people in foreign countries increasingly choosing to invest in the US stock market. I’m not an economist so please steelman this hypothesis.)

    • Foo McBarson

      This would not even necessarily require stock market investment to have gone up; it’s possible that intangible assets just got a lot cheaper.

      Yes if this all was true then we would expect it to be more profitable to start new companies, since you can capture that rent of the difference between market cap and tangible assets on IPO. So it might be interesting to chart the growth of venture capital as well. Although common wisdom in e.g. Silicon Valley is that venture capitalists are not especially sophisticated investors with a strong herd mentality, which seems to be somewhat common for people that invest other peoples’ money due to principle agent considerations (?) So if you really could make a nice chunk of change by simply cloning GM and offering it for IPO, I wouldn’t be surprised if venture capitalists refused to do this because it’s just not the sort of thing they do.

      I suppose if my “stock market is overvalued” hypothesis is true, we should expect to see increasing price to earnings ratios over the relevant time periods, and we should expect that people who are wealthy from starting businesses should be more and more wealthy as a result of stock sales/ownership and less and less wealthy as a result of dividends paid on the shares of the companies they own. I know that dividends are less popular than they once were; how does this fit in?

    • Foo McBarson

      You talk about firms in the S&P 500 outsourcing their work to firms outside the S&P 500, but another story is that each firm in the S&P 500 has gotten much better at choosing a single core competency with great economies of scale and selling it as a service to all the other firms. What this might look like would be firms increasingly outsourcing the capital-intensive aspects of their business by e.g. having Flextronics do all of their manufacturing, FedEx do all their deliveries, Google do all of their marketing, etc. and tangible assets like Google ad servers and FedEx trucks are now being used much more efficiently since they are shared across many more firms.

      The too obvious explanation: the increased role of software, even in non software firms (if GM purchases an expensive CAD software license for all its engineers, is that a tangible asset? How about its Google Apps subscription that means there is no need for as many mail rooms or copiers? In general I assume as soon as you switch from buying to renting you no longer have a tangible asset? So if hypothetically companies now rent office buildings instead of buying them that could potentially explain a large fraction of the change?) And of course many software firms have obvious network effects (eBay, Facebook) that make them hard to unseat and contribute to their valuation. Even a firm like Amazon’s value arguably comes in large part from its relationships with a huge variety of suppliers.

  • What about location value? Presumably these businesses developed over time in prime real estate locations that have become more crowded and dense. That has caused them to develop trading relationships with immediate neighbors. A competitor could buy the office supplies, equipment, and so on, and hire all the necessary workers, but moving to an equivalent location would be vastly more expensive/difficult.

  • Tatil_S

    Every acquisition where the price was more than the tangible assets resulted in goodwill as a (sort of fictitious) asset to the acquirer. We’ve had a lot more time since ’75 to accumulate goodwill.

  • Tatil_S

    Value of time. Most of these intangibles are not difficult to copy, but it takes time to put everything together. Recruiting employees with the right skill set, learning which vendors are reliable, negotiate prices, getting potential customers to learn your name, figuring out little tricks here and there to make your product or company work more smoothly etc.

  • 3rdMoment

    Robin’s calculation in his second update (Added 8p) seems not to be done correctly.

    t=tangible book value of equity
    e=total book value of equity
    m=market cap
    d=net debt

    Let’s do the calculation for 2015:
    Ocean Tomo tells us that t/m=.16
    FT link tells us d/e=.42
    The following source tells us m/e = 2.81

    Therefore (t+d)/(m+d) = (.16*2.81 + .42)/(2.81+.42) = .27

    So intangible percentage is 73%, not 59%. To get Robin’s answer you would need to assume m/e =1.

    On the other hand, the FT data was for all non-financial corporations, not S&P 500 firms. Debt to equity for the S&P500 is higher, around 1, according to:

    Using d/e=1 gives us an intangible share of 62% for 2015.

    We could redo the calculation for 1975, but it would not change the conclusion that the tangible percentage in 1975 was not too far from 100%.

    It probably does make sense to exclude financial firms when looking at this issue. (In fact before 1976 the S&P 500 did not include financial firms.)

    I’m still working on this but in looks to me like:

    1. However you look at it, “intangible” value seems to be more important today than in past decades.

    2. When you include debt as part of “value” (as you should), it is inaccurate to say that 5/6 of firm value is intangible dark matter. But it is still correct to say that over half of value today is intangible.

    3. The 1970s was somewhat anomalous, due to very low stock prices relative to fundamentals such as sales or earnings. If you go back to the 1960s intangible value looks significantly more important.

    4. The changes over the last 15 years have been fairly small. Most of the action was before 2000.

  • Vivian Darkbloom

    The comments here don’t seem to share a common understanding of the methodology used to create that graph.

    The graph indicates “intangible assets *as a percentage of market cap”*, not as a percentage of balance sheet assets (emphasis added within quote). This leads me to believe that the data was derived by taking the market cap of each company and subtracting the tangible assets as they appear on the balance sheet. The residual value would be “intangible”.

    If I am correct, then most of the “intangible assets” counted for this study do not appear on the balance sheet at all. Patents, copyrights, trademarks and acquired goodwill appear on the balance sheet of a company; however, the excess of market value over all balance sheet items would be un-acquired goodwill. I strongly suspect that this residual value is by far the largest component of the “intangible asset component” and a very small portion would be patents, trademarks and copyrights, or even acquired goodwill.

    Some reasons, not already mentioned, why “intangibles” as computed above, would be much higher today then in 1975. First, companies on the S&P 500 command higher earnings multiples. This may be due to low interest rates today and therefore lower discounts applied to future earnings. If everything on S&P 500 balance sheets remained exactly the same, but investors pay more on the market for those shares, this is reflected, under the above methodology, as un-acquired goodwill–an intangible asset.

    Second, globalisation may explain much of the increase. Companies on the S&P 500 command larger markets. This drives up the market intangibles, both acquired (on the balance sheet) and un-acquired (simply reflected in the market price).

    • Nioe my answer covers your point, please read better. Confront best answers.

      • Vivian Darkbloom

        You mean the best answer was the bit about naked women and fighting dragons?

      • yep.

  • Vivian Darkbloom

    And, apropos globalisation, a not insignificant portion of the “bricks and mortars” (or plant and equipment”) that would have been reflected on the balance sheet of an S&P 500 firm is now reflected on the balance sheet of a Chinese company, an Indian company, a Brazilian company, etc. Would you find the same split on the markets in those jurisdictions? I doubt it.

    A final point—if you think about it, a major portion of the “goodwill” as reflected by the method described in my earlier comment would be a reflection of increased productivity of those S&P 500 firms. They are doing more with less. Apple was not on the S&P 500 in 1975. Today, its market value is about 20 percent of the S&P. I’d bet most of their “intangible assets” is in the form of “un-acquired goodwill”, not patents or other intangibles reflected on the balance sheet. It is a very good example of what a global market can add to those market intangibles.

  • The selection hypothesis is very interesting. I read something recently about Nike not owning any factories, and really just having a tiny labor force, with all the actual production being subcontracted out to other firms overseas. So basically all the phone owns is the brand and some shoe design facilities, despite being incredibly valuable.

  • brendan_r

    1) Home Depot’s Price/Book is 16. Their ROE is near 60%. They’re more profitable, and more dependent on intangibles (in an accounting sense) than Apple and Google. By far. To explain the intangibles puzzle you gotta understand bizarre cases like Home Depot, I think.

    2) Don’t forget that stupidly deployed tangibles are worth less than their cost; many public companies trade below tangible book value.

    In a multisegment firm that means bad segments can obscure the intangible value of good ones.

    So a reduction in bad segments could cause measured intangibles/tangibles to rise, even though intangible value hasn’t changed at all.

    If CEO’s make fewer bad investments, launch fewer doomed to fail ventures, focused more on entrenching their core, were more skeptical of the scope benefits of diversification/conglomeration -in short if they wasted less tangible investment – you’d see intangibles/tangibles rising.

    3) Industries tend to have three profitability phases. A) Super profitable when they first emerge, because they admit few players w/ efficient scale and capabilities. B) Then brutally competitive as growth attracts delusional wannabes w/ out coherent strategies for achieving sufficient market share (and again, doomed firms, wasted tangible investment, reduces everyone’s P/book). C) Finally, more profitable again (most profitable on an absolute basis, as the industry is now much larger than in phase A) as the losers shake out, and the winners cement their incumbency.

    My gut is that this sort of thing played out in many IT industries between 1975 and 1995, which is the period when intangibles rose fastest in the bar chart above.

  • Silent Cal

    Technology companies may not be the driver of this trend, but they seem like its paragon. The infamous Yo funding as well as the Whatsapp acquisition and the Snapchat offer all seem to be treating users, rather than technology, as the company’s main asset.

  • Christian Kleineidam

    Maybe stocks of companies were undervalued on average 40 years ago compared to today. Maybe today’s stocks are overvalued.

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  • brendan_r

    How fine-tuned are HHI indices?

    For example, analysts consider Fabrinet an “electronics contract manufacturer”, a massive industry 1,000 times larger than Fabrinet. But in fact they’re an optical component manufacturer and have 50% market share.

    Another: Mocon is superficially an Industrial Instrumentation firm. In fact, their instruments do one thing: measure the rate at which substances permeate through materials, which is useful in food packaging. They must have more than 50% share of this space, if not 90%.

    Defining market segments accurately is extremely difficult for industry insiders to do; and they’ve got little incentive to publicize their findings.

    Wonder whether HHI’s ability to carve the economy at it’s joints has deteriorated.

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