On September 7th, the CFA Society Chicago welcomed Gautam Dhingra, CFA, the CEO and a portfolio manager at High Pointe Capital Management, LLC to discuss incorporating intangible assets and ESG factors into stock selection.
According to Mr. Dhingra, there are multiple examples of intangible assets; patents in the case of Qualcomm, brands like Pepsi and Apple, difficult to replicate assets like Union Pacific railroad, or sanctioned oligopolies like Moody’s, to name a few. When looking to use these intangible assets one should look beyond accounting data and focus on ‘what really matters’, or historical financials versus future economic profits. Much of the value derived from intangible assets, like the ones mentioned, cannot be found on a balance sheet, rather derived through future pricing power or lack of competition, for example. In the growing information based economy, traditional accounting won’t be as useful going forward and stock selection models must be adapted to incorporate intangible assets to find an edge and outperform. An increasing proportion of companies’ values are being derived by intangible assets, which poses a question; should one view Procter and Gamble and Qualcomm as peers, both benefiting substantially from intangible assets? The answer is yes.
The speaker discussed another form of intangibles, Environment, Social, and Corporate Governance (ESG), which can be described as putting your money to work into companies that follow good practices, e.g. treat their employees and other stakeholders well. With employee satisfaction having shown a strong correlation to stock performance by one study, some 3.5% per year above its benchmark, adjusted for characteristics, which found that it could be a leading indicator to predicting earnings surprises.
High Pointe conducts its research into ESG and other intangible factors and inputs it into its model that combines ‘franchise quality’ and ‘expected growth’ in an effort to find great stocks. The company seeks to find a business’s ‘franchise quality’ by ranking stocks on a variety of factors, including ‘how good is the business’ (using barriers to entry, degree of competition, pricing power vs. customers, pricing power vs. suppliers, and suitability of advantage) and ‘how well is this being managed,’ which includes management, employees, and governance.