Accounting May Mask the Appeal of Disrupters

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COMMENTARY 2/4

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A Timely Issue We believe many companies that are best positioned to grow their earnings have business models that are based on using intangible assets to disrupt industries and capture market share. Consider the following: • Prices for products sold by innovative companies are driven, in large part, by the value of intangible assets, such as designs for novel medical devices or algorithms used for digital marketing. These types of companies may be less susceptible to the impact of rising labor costs. For many traditional manufacturers, however, revenues compensate companies for providing manual labor, such as operating assembly lines. Rising labor costs can therefore have a more direct impact on traditional companies’ earnings. • The digital economy is expanding rapidly—even though freight shipping has been declining, investments in software are growing as companies increasingly digitize their operations and create novel services. This is part of a broader trend involving the significant growth in the prevalence of intangible assets (See Figure 1). EATHERBIE CAPITAL

We believe many companies that are best positioned to grow their earnings have business models that are based on using intangible assets to disrupt industries and capture market share.

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Figure 1: Companies’ Market Values Are Now Driven By Intangible Assets

Intangible Assets as a Percentage of Market Capitalization

+6.3%

84%

17%

1975

2018

Source: Ponemon Institute. Market capitalization is that of the S&P 500 Index.

Digital Disruption Digital advertising is an example of how innovation and intangible assets, such as algorithms that pitch targeted content to consumers, are driving secular growth. In 2018, digital advertising revenue increased 21.8%, according to the Interactive Advertising Bureau, and we estimate that it grew 19% in 2019. Even more impressive, the indispensable nature of smartphones and tablets contributed to revenue frommobile device advertising increasing 31% in 2019, according to our estimates. Revenue for streaming video and audio advertising is also growing rapidly. The Trade Desk Drives Secular Growth The Trade Desk provides a cloud-based software platform for planning, launching and monitoring advertising campaigns. It is also used to allocate spending among channels and to report and analyze campaign results. Trade Desk’s year-to-date net income as of September 30, 2019, increased 17.8% year-over-year. During that period, the company poured $84 million into technology and development, up 40% from the same period in 2018. If accounting practices allowed intangible assets to be fully capitalized, the Trade Desk’s year-to-date net income would have shown an even larger increase.