Unfortunately, this particular book is a bit uneven. I believe it's likely that his earlier book, which I don't have, would have been the preferable one to start with, but I'll go ahead and start here, discussing the issues as they come up.
The first chapter is really introduction, and talks about his website http://www.StandardsInstitute.org setting the stage for the book's tension between sales pitch and discussion of the issues. Though I'm not past Chapter 2, it seems clear that this book is intended for financial analysts, and likely that Dr. Standfield doesn't have much experience in the financial industry.
So I'm going to help things along with my commentary, and see if I can't find Dr. Standfield and urge him to respond.
Chapter Two
Well, unfortunately this just starts out poorly.
First, there's an assertion, "Stock Prices Measure Competitive Advantage." In a seeming attempt to prove this assertion, Dr. Standfield commits one of the most common logic fallacies around (and incents me to get back to work on that topic!):
He saids that when a firm's competitive advantage increases, this increases market value, earnings, revenues, etc. Clearly, part of that's true: if a firm has an advantage against its competition, we would definitely expect increased revenues. We wouldn't necessarily see increased profit, as the company might have disproportionately larger costs; we certainly wouldn't necessarily see increased market value.
But I'm betting that Standfield is making a point about what Competitive Advantage is, so giving him the benefit of the doubt and assuming his assertion is true -- that an increase in competitive advantage shows an increase in market value -- he then says that the opposite true: an increase in market value implies an increase in competitive advantage. In other words: If A -> B, then B-> A.
Mathematics break for everyone!
This isn't necessarily true. The real logic is:
if
A -> B
then
NOT B -> NOT Aso
Competitive Advantage implies increased market value
means
NO increase in Market Value implies there is NO Competitive Advantage.(Think about it: If "Ferraris drivers are all reckless" is true, then "No reckless drivers means there are no Ferraris" is also true, but "Reckless drivers all own Ferraris" isn't true because obviously someone might be driving a Corvette or Toyota recklessly.)
But there are bigger problems afoot than simply a logical misstatement:
"Stock Prices Measure Competitive Advantage"? Well, no. Stock price, if it's reflective of anything real, is reflective of Supply vs. Demand for that instrument.
To illustrate, I'll tell a story. There were once two securities traders, let's call them Bert and Ernie. Bert and Ernie were both extremely competitive and athletic, and one day decided to race a 440meter to see who was fastest. Naturally, given traders' propensity for this sort of thing, there was much betting. However, people just didn't say one person would be faster than the other. Almost everyone held several bets for different results with many people so that they each had a profit curve so that their winnings would depend on the actual spread. Bert and Ernie -- being "insiders" as to how fast they were -- had themselves estimated that Bert would be 4 seconds slower than Ernie, so virtually everyone's bets were in the area of Bert being 6 seconds slower to even with Ernie. Most people agreed that Bert would die trying rather than lose, but that was all the "color" there was.
You guessed it, not only did Bert win, but he won by 11 seconds. Eleven seconds in a 440 is a LOT. The market, consensus driven by people who allegedly knew their relative strengths, was utterly wrong. Even had people taken Bert's competitive spirit to the extreme, it's hard to imagine anyone betting beyond 4 seconds the other way: that Bert would be 4 seconds faster than Ernie. But he was 11 seconds faster.
What does this mean? It means that the market is just an arbitrary agreement of the value of the company, which is to say the net present value of future cash flows (which are, of course, estimated by modeling the presumed success of the company, which is definitely determined by the company's competitive advantage... but also industry regulation, market environment, etc.). There are several components to pricing, most notably:
- Instrument related, such as stocks whose companies have convertible debt or convertible preferred, which means that some funds might hold these stocks (or short) to hedge
- Portfolio related, such as stocks that are in-demand (or eschewed) because they satisfy common portfolio criteria -- such as for industry, capitalization size, or geography -- or because people know there will be regulatory changes or the economic environment makes a sector particularly hot or not
- Market Popularity, such as for stocks that are in an index or at some popular "technical" breakout point
- Event-related, such as stocks that are having earnings announcements (transient), or that are deeply committed to production in an area of the world suddenly experiencing political turmoil or weather issues (destruction of capacity can be substantive).
However, I believe that where Standfield was going was that stock prices SHOULD increase if competitive advantage increases. That is, everything else being equal, the company with the higher competitive advantage should have a higher value stock. The problem is, everything else isn't equal.
I think a better way to think about Stock prices is to think about investing in art: if the artist is a Major Talent, that's a necessary condition, but it's insufficient because at any given time the artist might be popular or not. While you can still enjoy art if you buy a bit too early and have to wait for it to appreciate, if you invest in a company before the market begins to recognize how well-run and strategically well-positioned it is, the price is flat and there's not any entertainment value in that.
But, despite the not-so-great trading rationales, Standfield is
absolutely brilliant when he's talking specifically about what the
intangibles are, and we can certainly get to why it's so important to
value them when talking about securities trading:
For example, he talks about the two main types of intangibles as being Knowledge and Relationships. While knowledge has been somewhat examined, his examples of what happens with there are low/poor relationship assets are telling:
- Poor customer service
- Low customer satisfaction
- Poor morale
- Unhealthy stress
- Excessive conflict
- Unknowledgable staff
- Emotionally unintelligent staff
He talkes about intangibles being broken into "soft" and "hard" subcategories, where hard intangibles are the ones we're used to: Brand, R&D, Intellectual Property, and Goodwill, i.e. those intangibles that have legal validity. "Soft intangibles" are those things such as resilient morale and good working relationships ... that lead to the "hard intangibles" such as brand ... that finally lead to the "tangibles" such as the revenues generated from a competitively successful product.
He then goes on to say that it's "management of competitive intangibles that creates or destroys competitive advantage and therefore share price."
Well, once again I disagree about the relationship between competitive advantage and share price; however, I do believe we've arrived at the reason why financial analysts would care about intangible valuation: I'd reform what he said above as
If intangibles were correctly accounted for within the organization, then the company could give guidance to analysts in a way that significantly increases their probability of successfully estimating future cash flows, thereby reducing uncertainty and its associated volatility.
Standfield also points out that Firms can't own soft intangibles. You can't own the knowledge in someone's head before s/he realizes its significance and documents it, just as you can't own the pleasant comeraderie two people who work together well have for one another. It's unownable.
This is a key point, as clearly this can be a scary thought. If you admit to the existence of soft intangibles, then you also admit to a lack of ability to own them. Then what?
Well the truth is that, in the same way that a sales force has a lot of relationships with people who haven't actually purchased a product but who are still assets, if a company understands its soft assets, then it can develop strategies to keep knowledgeable people around and strong teams intact.
If you think about it, it's actually far scarier to think that companies have these soft intangible assets, haven't identified them, certainly haven't valued them, and so they're being squandered.
So, to recap, I want to state that conclusion of Standfield's again, because really it's the crux of the problem:
Soft intangibles create Hard intangibles, which create Tangibles
He calls soft intangibles "Competitive" components, Hard are "Legal," and Tangible are "Financial." And there, you can see exactly what the problem is: while we have constructs as a society to identify financial and legal positions, to know what is "more" financially (more money), and "more" legally (more likely to win a legal challenge), we don't really have any sense, as a society, how to define "more" socially. What is "more" morale?
I believe the work that must be done here is to quantify exactly
this: what are the underpinnings of social assets, and how do we talk
about and measure what is "more" of them?
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