Stocks Are Under Pressure. Add This Accounting Entry to the Risks.

Text size

Weakening demand, inflation, and higher interest rates aren’t the only risks investors face in this market. Accounting is a risk too—and it could be a much bigger problem than in the past.

We don’t mean outright fraud, like that perpetrated by WorldCom and Enron in the early aughts. Instead, it’s the little details on income statements and balance sheets, the kind that don’t matter in good times but carry more weight in a bear market.

One area in particular deserves scrutiny—so-called intangible assets. They are exactly what they sound like, assets that can’t be touched or felt but live on balance sheets in the form of goodwill, trademarks, brands, and other intellectual property. Since the 2008-09 financial crisis, the value of intangible assets on corporate balance sheets has exploded. That raises the odds of asset write-downs amid slowing economic growth and falling stock prices.

Credit Suisse accounting analyst Ron Graziano calculates that intangible assets now account for about 30% of the total assets of the 500 largest U.S. companies, excluding banks and real estate firms. That’s up from a little more than 5% of assets a decade ago. Unlike tangible assets, such as a truck or a tractor that gets amortized over its useful life, intangibles can last forever—unless something goes wrong. Companies have to test at regular intervals to see if an intangible asset has been “impaired,” or, essentially, worth less than it was purchased for.

Many things can go wrong. Higher interest rates, lower growth projections, and even lower stock prices can impact the valuation of those assets. “These intangibles could have been purchased at much different valuations, especially if they were purchased last year,” explains Graziano.

He recommends looking at the ratio of intangibles to market value. The higher the ratio, the more an asset impairment can hurt investors. He highlights four companies whose intangible assets were recently at more than 200% of their market caps: pharmaceutical company

Viatris

(VTRS), healthcare-services provider

Teladoc Health

(TDOC), security company

ADT

(ADT), and software provider

Clarivate

(CLVT). Consumer-staples firms

Post Holdings

(POST) and

Coty

(COTY) had high ratios too—in the 160% range.

Viatris and Clarivate said they test their intangibles as required, while Post and ADT declined to comment, and Teladoc and Coty didn’t respond to requests to comment.

The ratio is just a starting point, Graziano says. Once investors identify companies with high ratios, they have to dig in to understand the risk unique to each situation. Alternatively, investors might choose to ignore the balance-sheet risk altogether, arguing that intangible impairments are noncash charges and they don’t really matter for the future-focused stock market.

Graziano counters that intangibles represent cash spent previously—and that companies forced to write down their intangible assets tend to underperform the market for years after the impairment happens.

Ignore them at your own risk.

Write to Al Root at [email protected]