The ability to find businesses with durable economic moats that are available at reasonable prices can mean the difference between consistently superior investment results and mediocrity. Intuitively, it is obvious that companies with powerful brands will enjoy economic moats that can generate high returns on invested capital on a consistent basis. However, knowing how much to pay for a brand is difficult because it is not always easy to quantify brand value in a manner that value investors are comfortable with.
The Financial Times published a special report today (also available as a pdf file) that attempts to quantify brand value for the top 100 global brands. The top global brand remains Google followed by IBM, Apple, and Microsoft. Coca Cola, McDonalds, and Marlboro are familiar consumer products brands that appear in the top 10 list. The survey was developed by BrandZ and is based on quantitative consumer research and financial analysis.
How Does the Brand Contribute to Earnings?
The financial model calculates brand value by examining each brand’s ability to generate demand. The dollar value of each brand is predicted based on future earnings attributable to the brand discounted to present value. The analysts developed the concept of “brand contribution” to differentiate between earnings that are driven by brand equity versus other factors.
Obviously a great deal of judgment is required to identify earnings that can be attributed to the presence of brand value. In addition, estimates of future earnings are necessarily imprecise particularly for the brands that are more subject to technological change. Investors can be nearly certain that brands such as Coca Cola, McDonalds, and Marlboro will provide value decades from now but the same cannot necessarily be true for brands such as Google that represent economic moats that have been formed over a much shorter period of time.
How Durable is the Brand?
The question of brand durability is critical when considering an investment. In addition, the more an investor pays for brand value, the lower the margin of safety if there is any question regarding brand durability. For the sake of argument, assume that we accept the BrandZ methodology. If so, Google’s brand value is estimated to be $114.3 billion while its current market capitalization is approximately $169 billion. In contrast, BrandZ estimates Coca Cola’s brand value at $68 billion compared to a market capitalization of approximately $123 billion.
The purpose of this observation is not to comment on the valuation or relative attractiveness of Google and Coca Cola but to point out the need for investors to clearly understand that when they pay premiums over tangible assets in order to acquire a brand, it is critical to be able to estimate the durability and earnings power of the brand ten or twenty years from now.
How many of us could have predicted technological marvels like the iPad ten or fifteen years ago? Maybe some insightful individuals were able to but nearly anyone in 1990 or 1995 could have predicted that people would be drinking Coca Cola and eating at McDonalds in 2010.
Disclosure: No direct positions in companies mentioned in this article.