When it comes to business assets -- the things a business owns -- not everything falls into the same category. Some things are easy to value and also easy to sell if needed. Others are more abstract. And that's why it's important for investors to know the difference between tangible and intangible assets.
Knowing a business's tangible assets can help you find attractive investment opportunities and can also help you separate safer investments from riskier ones in many cases. In this article, we'll discuss the difference between tangible and intangible assets, some of the most common examples of each type, and how tangible assets can be used in your investment research.
What are assets?
In business, assets are any items owned by a company. Does your business own a delivery vehicle? That's an asset. Does it own a computer, desk, chair, or sofa? Those are assets as well.
Obviously, business assets can be far more complicated than that, especially when you start talking about billion-dollar enterprises. But the general idea is that if something is the property of a business and has value, it's an asset.
What are tangible assets?
The simple explanation of what the word "tangible" means is "things you can touch and/or see." In business, a tangible asset is one that not only has a determinable monetary value but that generally also has some sort of physical form.
Real estate is one obvious example. If your business owns the building it operates in, that's a tangible asset that can be sold if needed and for a price that should be pretty close to its assessed market value.
Tangible assets can be broken down further. They can be classified as current assets (those that can be easily liquidated) or fixed assets (also known as long-term assets). Real estate would be an example of a fixed tangible asset, as it could be sold, but it isn't the most liquid asset, nor are most businesses planning to quickly dispose of their real estate at any given time.
On the other hand, something like a stock portfolio would be classified as a current asset, because it could easily be liquified, or converted into cash, at full market value, and at a moment's notice.
While this isn't an exhaustive list, here are some of the most common examples of tangible assets companies own:
- Cash equivalents (short-term Treasury securities, CDs, etc.)
- Marketable securities (like stocks)
- Accounts receivable
- Real estate
- Manufacturing equipment
- Computers and other electronics
- Office supplies
- Vehicles owned by the business
What are intangible assets?
On the other hand, companies often own some assets on their balance sheet that don't have any physical form and generally have difficult-to-determine values. For example, if a technology company owns 1,000 different patents, it may believe the intrinsic value of those patents to be in the millions or even billions of dollars. And they might be right.
But the precise valuation of assets like these can be impossible to determine, and they often cannot be liquidated if needed. For example, a brand name is an example of an intangible asset that can typically only be sold as part of a sale of the entire business. Think of Coca-Cola (NYSE: KO). If it decided to sell the Coca-Cola brand, would the company be anything close to what it is today?
With that in mind, intangible assets can include, but are not necessarily limited to:
- Patents and trademarks
- Brand names
- Goodwill (when one company acquires another for more than its net asset value)
Why are tangible assets important to know?
From an investor's perspective, tangible assets are important to know for a few reasons when doing research.
In simple terms, tangible assets tell you how much a company is actually worth. In other words, if a business were to lock its doors, cease all operations, and sell everything it owned, tangible assets tell you how much money a company would have to distribute to investors.
One important concept this ties into is "margin of safety," which is a favorite of legendary investor Warren Buffett. As Buffett puts it: "On the margin of safety, which means, don't try and drive a 9,800-pound truck over a bridge that says it's, you know, capacity: 10,000 pounds. But go down the road a little bit and find one that says, capacity: 15,000 pounds."
In other words, look for a "cushion" when you invest. If a stock is trading for a market capitalization of $2 billion and owns $3 billion worth of tangible assets, that's a pretty big margin of safety in case things go wrong in the business itself.
One popular valuation metric you can use in your stock analysis is price-to-tangible book value. (Note: Book value is simply another way to say the total value of a company's net assets.) To calculate this, simply divide a stock's current price by the value of the company's tangible assets on a per-share basis. For example, a stock trading for $75 with $50 in tangible assets per share would have a P/TBV ratio of 1.5.
It's somewhat rare to find companies trading for less than the value of their tangible assets unless there's something very wrong with the business. But the key takeaway is that a lower P/TBV ratio indicates a better margin of safety in the form of the company's tangible assets.
On a similar note, it's important to know that many companies (and investment analysts) value companies based on their total asset value, or book value, which includes intangible assets. While many intangible assets do have value, it's a less reliable valuation method than using tangible assets, as most intangible assets only have a theoretical value, and it's very tough to say what they would actually sell for (if anything at all) on the open market.
Finally, remember that using the P/TBV value of a business is only one metric and should be used only as part of a more thorough analysis. A low P/TBV alone doesn't necessarily make one stock cheaper than another. For example, if one stock trades at 1.5 times the value of its tangible assets and is growing its earnings by 10% per year and another is trading for 2.5 times its tangible asset value but is growing by 20% per year, can you really say that the first one is the better value?
The Millionacres bottom line
Knowing what a business's tangible assets are can play an important role when trying to find investments that are a good value and have a solid margin of safety. This can be especially important for real estate investors, as real estate investment trusts (REITs) and other real estate businesses tend to be very asset-heavy, with most of their assets falling into the "tangible" category.