Last year, in “Reimagining the Financial Statements” (The CPA Journal, April 2015, http://bit.ly/1SSQXz7), this author restated certain fiscal metrics of Apple Inc. to incorporate the value of the company’s intangible brand asset. Although such assets are not capitalized under GAAP, the article noted that the recognition of Apple’s brand value would result in the transformation of a key financial ratio that would enable analysts to restate an outlier metric to a less statistically extreme value. By applying data transformation techniques to such extreme values, the article concluded that financial analysts could avoid excluding outliers from their portfolio analyses and thus improve their techniques of statistical analysis. But the article did not extend these data transformation techniques beyond Apple to comparable technology companies, and thus could not test its conclusion against a portfolio of similar equity investments. This article presents such a calculation and assesses the results.
Another Big Four
Apple, Amazon, Facebook, and Google are often called “the Four Horsemen of the technology industry” (Paul R. La Monica, “Why You Need to Own the Four Horsemen of Tech,” CNN Money, July 17, 2015, http://cnnmon.ie/26xm9Ia). Therefore, it would be appropriate to create a theoretical portfolio of the Four Horsemen’s equity securities and assess whether the author’s data transformation technique would enhance analytical techniques when applied to all four companies.
The Exhibit provides the results of this assessment. For each of the four companies, the price/earnings ratio is restated for 2015 in order to incorporate the intangible value of the company’s brand asset. Utilizing the author’s approach, the transformation process incorporates the assumption that an increase in the value of a brand asset would result in an unrealized gain.
Restatement of Price/Earnings Ratios
The results? The actual 2015 price/earnings ratios, calculated by Zacks Investment Research and presented on Nasdaq’s website, range from 33.95 to 496.60. That range produced an enormous standard deviation of 229.67. By comparison, the restated price/earnings ratios range from 6.19 to 32.65, with a far more modest standard deviation of 11.06. Clearly, reimagining the financial ratios greatly reduces the excessive variation in the price/earnings metric. This outcome is consistent with the April 2015 article, where the transformation process reduced an extreme prior-year Apple metric to a more modest level.
The price/earnings ratio is a heavily utilized metric that represents a foundation of modern portfolio analysis. Therefore, the recognition of intangible assets (or intellectual capital, under the International Integrated Reporting Framework) can significantly facilitate the traditional processes of portfolio analysis. In other words, the framework does not merely add new metrics to the traditional financial ratios of accounting; it also improves common metrics that have been in use for decades.