Like millions of people, I ride an elevator up to our office each day. It's a daily routine for me and millions of others in the global game of commerce. We take certain things for granted, such as an elevator, or who might be riding with us in the elevator.
Nearly every business is comprised of a mixture of tangible assets--factories, production equipment, inventory and vehicles--along with intangible assets including brands, patents, trademarks, reputation, business methodologies, or expertise. We're going to discuss the really soft stuff: reputation, business methods and expertise. These intangible assets have enormous value, until Google figures out how to build learning robots and renders us all obsolete.
Yes, some of the most important economic assets a company possesses are not listed on the financial statements. But accounting is only an approximation of economic reality. One of my favorite quotes is from Albert Einstein: "Not everything that counts can be counted, and not everything that can be counted counts." Hey, he just described the accounting profession!
Certain businesses derive their economic value not from buildings, equipment and the like but from intangibles, including reputation, methodologies and expertise. The real assets are the people who manage and operate the business. In these businesses the valuable assets go up and down the elevator every night.
Businesses such as financial services--we can relate to this--are highly dependent upon the people who manage the business. We've seen numerous examples of well-run and poorly-run financial businesses, and the primary distinction between the well-managed survivors and the road-kill is the quality of the people, the strength of the culture, risk-management, etc. Soft concepts but hard realities. It's all about the people running things.
For every well-run Wells Fargo there are too many Lehman Brothers, Washington Mutual, Bear Stearns, Fannie Mae, Freddie Mac, Wachovia or Countrywide Financial. Financial crisis road-kill. What they shared in common was a willingness to own poor quality assets combined with a further willingness to borrow excessively--leverage--that created a situation where a bit of trouble with asset quality magnified the damage due to their leveraged balance sheets.
Large institutions undone by managers who mismanaged these firms. It's a Darwininan process--the better-run firms managed through the crisis and survived. The weaker players have joined the Dodo bird, the Saber-toothed Tiger and Tyrannosaurus Rex-in extinction.
Since we can't see inside a manager's head--again Google may eventually solve this problem--we pay lots of attention to the "track record" of managers in certain businesses where people can either create success or make a mess.
-John Heldman, CFA