Checklist Series, Part 5: Intangible Assets
We have now entered into a new part of the checklist - that where we evaluate where the company might possess a sustainable competitive advantage that will allow it to earn a higher ROI over time.
Sustainable competitive advantages are the holy grail of investing. Many businesses will have temporary competitive advantages, but far fewer of them will be durable over the business cycle, or beyond. The more durable, the more valuable.
The cornerstone of the sustainable advantage is the intangible asset. If it was tangible, perhaps I’d be able to replicate it, or acquire it for myself. But it’s not! It’s intangible. And that can make it virtually impossible to compete against.
If you gave me $100 billion and said take away the soft drink leadership of Coca-Cola in the world, I'd give it back to you and say it can't be done.
Warren Buffett
Brands are an obvious one. We all know that the right name or logo on a package can miraculously turn a 10 cent cup of coffee into a $5 Grande Starbucks Pike Place Roast. Branding is valuable! But you can’t create a brand overnight. It requires vision and execution, and more companies fail trying than actually succeed in creating enduring brands.
What else? Patents are the OG of intangible assets. If I can own a patent on a product or process, it gives me the required head start over my competition. I had better use it to create that desirable brand, because when my patent expires, I’m going to need it! Everybody knows that Tylenol is just acetaminophen. The patent has long-since expired, and you can buy a no-name product at a fraction of the cost of the branded pill, but it’s a brand that people are willing to pay more for, no matter how irrational that preference may be.
Regulatory licenses are another valuable intangible. These licenses can create cost advantages or barriers to competitors in industries where this isn’t common to see. These can come into play when it comes to commodity products like telecommunications. These are among the weakest moats, though, because they can often disappear with a stroke of a pen (and are more likely to do so as long as populist politics rule the day).
Ultimately this isn’t even scratching the surface of what might constitute an intangible asset. We can look for other things like network effects, high customer switching costs, trade secrets, data, distribution channels, or even corporate culture. Anything that can’t be replicated easily by a competitor — even one with limitless financial capacity — can be considered an intangible asset.
Show me the money
Possession of an intangible advantage isn’t enough. How does one define a “strong” intangible asset?
Let’s consider brands. I might love a brand personally, but that doesn’t mean it has mass popularity. It has to go beyond personal preferences.
Evidence of a strong brand must show up in the numbers. Does the company earn a higher ROI than it’s competitors? Does it have better pricing power? Is it able to raise prices without hurting demand, and maintain margins? Does it earn higher margins than the competition?
Sometimes the fruits of a strong brand are wasted by management operating an inefficient and bloated company. It allows them to coast while empire building and paying themselves massive bonuses. In this case, it’s only a matter of time before competitors seize the throne.
Moral of the story — and this can be applied to the analysis of any intangible asset — is that it’s of little value to shareholders unless management exploits it for their benefit.
Ultimately we are not just trying to find great companies. We are trying to find great companies worth owning.
You can catch up on prior entries in this series here: