Warren Buffett is one of the most intriguing figures in the modern investment world, and a major contributor to the development of professional securities analysis.
The big insight on which his reputation is based came about a half-century ago. It’s the observation that, although brand names and distribution networks are among the most powerful assets a company can have, they appear nowhere on the balance sheet and only as an expense on the income statement. (One exception: brands and networks are obtained in a takeover often appear on the buyer’s balance sheet as intangible assets.)
The quintessential example of this is a long-time Buffett holding, Coca Cola (KO):
–Over the past decade, KO has spent almost $40 billion world-wide on advertising, or about 15% of the company’s current market cap. Presumably, a new market entrant would have to spend at least this much if it hoped to create a similar awareness among customers. And even then the newcomer would likely be at best the #3 behind Coke and Pepsi.
–In addition, there are the costs of creating a distribution network. The actual KO distribution network is is complex and has changed over time. To offer a much-too-simple example, take the supermarket channel in the US. Red Coca Cola trucks regularly pull up to supermarket locations. A driver unloads product, takes it inside and stacks it on the shelves. A would-be competitor would need a similar distribution network and a similar set of agreements with customers. Again, a very significant expense.
Financial accounting works this way, I think, because it’s the simplest solution. The alternative would probably be to consider these expenses as assets and set up an amortization schedule for expensing them. This would be complicated, potentially highly subjective, and certainly open to abuse.
The power of brands and distribution are well-understood now. The today’s-world analogue, I think, is the value of the intellectual property in software creation and computer chip design.