Brands and the Stock Market - The Economy of Brands

BRANDS AND THE STOCK MARKET

Jan Lindemann

Brands are key corporate assets accounting for a significant portion of shareholder value. In 1987, the price to tangible book value of the Standard & Poor’s 500 Stock Index (S&P 500) exceeded 2 indicating that intangible assets were starting to become more valuable than the asset base reported on companies’ books. This ratio peaked at around 7 during the dotcom frenzy and stabilized after the 2008/9 market crash at 2.7 as of the end of the first half of 2009. The average price to tangible book value of the S&P 500 between 1985 and 2009 is 3.9 indicating that about 74 percent of the average long-term stock market value of all companies (including utilities, real estate, commodity and manufacturing businesses) included in the S&P 500 is generated by intangible assets such as brands, customer base, patents, organizational frameworks, and channel relationships. This is remarkable as the share price represents the NPV of all of the companies’ future expected cash flows. 

Many financial valuation studies and text books show that expectations of future performance are the main driver of shareholder returns. Across industries and stock exchanges, about 70–80 percent of a company’s market value can be explained only by cash flow expectations beyond the next 3 years. Brand specific studies also revealed that companies with strong brands consistently generate higher total returns to shareholders than their industry counterparts¹. These companies have proven their ability to generate superior returns in the past and their brands can convince investors that they will be able continue delivering these returns in the future. Studies conducted by consulting firms PwC, Interbrand, Millward Brown, and others demonstrate that brands account for 30–80 percent of shareholder value.² Over and above the past performance companies with strong brands generate higher expectations of future performance as a powerful brand is more likely to attract and retain consumers/customers in the future, can be leveraged into new channels, geographies, and businesses as Apple, Disney, McDonalds, IBM, and others have demonstrated. 

Investor’s assessment of a company’s future expected performance is represented by the price/earnings (P/E), i.e. the share price divided by annual earnings to shareholders. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. Companies that are expected to exist for longer and/or grow their earnings faster attract higher P/E ratios and have higher share prices. Although without further background on the underlying company and its markets, P/E ratios can easily result in a misleading interpretation, they are a key assessment ratio of the investment community. For the past 5 years the owner of one of the world’s most valuable brands, The Coca-Cola Company, was trading on an average P/E ratio of 21. Coca-Cola is the world’s largest beverage company and produces a range of non-alcoholic beverages including leading global brands such as Sprite, Fanta, and most notably Coca- Cola and Diet Coke. These four brands are among the world’s top five non-alcoholic sparkling beverage brands. Although Coca-Cola is an excellent company it is not operating in high-growth markets. Consumption of carbonated drinks is in a slow decline and more than half of its revenues and profits are generated in mature developed markets (56 percent of net revenues³). Nevertheless, as indicated by the 5 years average P/E ratio of 21, investors continuously believe that the company can deliver about 20 years’ worth of earnings (considering the discounted future earnings). Despite the rise of own label offers from retailers and squeezed consumers around the world investors believe that Coca-Cola’s brands, its management, and other assets can deliver more than two decades’ worth of further profits. This is an example of investors’ faith in the ability of companies with strong brands, like Coca-Cola, to generate profits more or less into perpetuity. Not surprisingly, Warren Buffet’s Berkshire Hathaway owns more than 8% of the shares of The Coca-Cola Company, making it its largest shareholder. 

In assessing the share price of a company analysts and investors are looking at a firm’s potential and capability to grow and deliver its profits in the future. There are three main drivers of profit growth: revenues; profit margins; and capital efficiency. Investors are looking for companies to deliver revenue and profit growth simultaneously. P/E ratios are positively correlated with organic revenue growth suggesting that topline growth is rewarded by higher share prices.⁴ This is exactly what strong brands can deliver. There is now substantial research evidence

FIGURE 14.1 Performance of brand portfolio

Source: see Madden, Fehle and Fournier (2006).

suggesting that strong brands correlate with superior share price performance. Aaker and Jacobson used a market research database called EquiTrend to examine the extent to which consumers’ quality perception of a brand provides information about a firm’s stock returns. Based on a panel data set of 34 publicly traded firms between 1991 and 1993, Aaker and Jacobson found a statistically significant positive relationship between quality perception and stock returns.⁵ Research based on brand values published by Interbrand in different rankings including the Financial Times and BusinessWeek until 2006 has indicated that strong brands not only deliver greater stock returns than a relevant benchmark portfolio but also do so with lower risk.⁶ The survey compared a portfolio of US quoted companies which brands are included in the survey (brand portfolio) with the rest of US stocks (rest of market) and the overall US market (see Figure 14.1). 

Although different portfolio strategies i.e., the weighting of companies’ stocks owning the brands, produce different results the study shows that the brand portfolio outperforms the overall market as well as the rest of market portfolios with respect to return and risk. The brand portfolio outperformed the non-brand portfolio by about 48 percent and the total market by 30 percent in average monthly performance with a beta of 0.85. It suggests that brand value provides an additional explanation to shareholder value and that companies that own strong brands listed in the BusinessWeek survey have superior riskadjusted performance. Similar evidence is provided by Millward Brown that found that the return of a portfolio made up of companies included in their BrandZ Top 100 over the 3 years the survey has been published delivered in the period 2006–8 a 20 percent higher return than the S&P 500 index.⁷ 

There have been also a range of academic marketing studies looking at brand management activities and their impact on share prices including changing of brand and corporate names,⁸ new product introductions,⁹ and brand attitudes.¹⁰ Also, the links between advertising and brand-related intangible assets including perceived quality¹¹ and brand attitude¹² have been established. In addition, there is also research that quantifies the direct and indirect brand influence on all the factors that determine the share price, such as cash flow, earnings, and share price growth, at around 70 percent.¹³ The breadth of the above studies clearly supports the notion that strong brands significantly enhance share prices and that improvements in brand perceptions have a significant and positive impact on firm valuation.¹⁴

Although putting brands on the balance sheet was a big issue for accountants and consultants it has had little impact on investor perceptions and how analysts assess the value of share prices. This is due to a focus on expected future cash flows rather than changes in the accounting regime. Analysts and investors can be influenced by changes in brand investments and initiatives but tend to be most affected by their financial impact. Changes in share prices are driven by expectations and changes in a company’s financial performance in particular by growth in EBITDA, cash flow and earnings per share (EPS). The better the growth prospects for revenues and profits the higher investors will value the stock. If the company can grow revenues and profits at a faster rate than its tangible assets it creates more intangible and brand value. However, financial results are lagging indicators. The effect of the brand happens earlier when they impact consumers’ minds and purchasing behaviors. Stock analysts try to pick up all available information on the companies they cover ranging from market research data to brand and business rankings. In addition, companies host analyst presentations and discussions in which directions about future investments and expected results are either explained or can be interpreted for use. 

However, brand specific information reported by their corporate owners is very scarce. Even with consumer goods companies where brands account for around 80 percent of value, the disclosure of brand investments and performance is close to non-existent. The Coca-Cola Company provides little information about one of its largest assets, the Coca-Cola brand, which according to the BusinessWeek’s annual brand survey is estimated to be worth around US$68 billion¹⁵ or around 50 percent of the company’s market capitalization. The company is proud to claim that the Coca-Cola brand is the most valuable brand in the survey. Yet, there is little of information on the performance of this asset and how it is maintained and invested in. Even the reporting on the acquired brands capitalized on the balance sheet is thin. The 2008 financial statements report US$4 billion of capitalized trademarks and advertising expenses of US$2.9 billion. In the notes there is some explanation on the names of the brands that have been capitalized. However, compared to the detailed reporting and explanations on capital expenditures, tangible assets such as property, plant and equipment, and the financial hedging strategy, the information on the brand assets is minimal. Although this is partly a result of the oddities of the accounting regulations the lack of disclosure or information about the performance and investments made in the companies most valuable assets, such as the brands, is remarkable. This situation is not limited to The Coca- Cola Company. Other consumer-facing businesses such as McDonald’s, Apple, Disney, Sony, BMW, Nokia, LVMH, and Inditex do not report significantly more on the performance on their brands. Although there have been many companies such as Samsung, HP, The Coca-Cola Company, Philips, and others that have been happy to report that they own valuable brands that are ranked in the BusinessWeek’s Best Global Brands survey further detail on their brand is scarce. 

This is probably a function of limited interest by investors and analysts and little desire of management to disclose competitive information. Financial analysts focus on the analysis and modeling of financial and economic data to assess the value of the entire business to derive their share price recommendations. Although information on marketing initiatives and brand performance is of interest most financial analysts feel much more comfortable with financial data as this is the framework they have been trained in and it is also the language of capital markets. Most analysts look with interest at the brand value surveys published by different consulting firms but they either have a limited understanding about how they have been put together or question the validity of the results. A survey among financial analysts in London showed that there was limited demand for more detailed disclosure on marketing assets and investments.¹⁶ This is not surprising as the relationship between consumer perceptions, behaviors, and their financial impact is very complex and requires a lot of data and understanding of the dynamics of the brand value chain. Analysts are much more comfortable in analyzing the financial results of brand and marketing impacts than linking market research data directly to financial results. In addition, the communication with investors focuses on financial ratios such as EPS, P/E, revenue and profit growth, operating and free cash flow, and ROE. Interestingly, the companies that own the brands have become increasingly sophisticated in tracking and analyzing the value creation of their brands and the return that their marketing investments and initiatives generate. Senior management of most companies now require detailed reporting on the performance and value creation of the company’s brand assets. Most CEOs have embraced the notion of brands being key business assets that require specific management attention. Many companies have included brand value as a key performance indicator into their reporting and remuneration process. At the same time they have limited interest in reporting details on their intangible assets that can communicate sensitive information to competitors. 

So should investors care about the value of brands and other intangibles? According to the research mentioned above probably yes. The announcement of brand values in the published rankings may not have a direct impact in moving share prices but stocks of companies with strong brands and high brand value outperform the rest of the market. This means investors implicitly recognize and value the contributions brands make to the underlying business. This should be sufficient evidence for investors to care about the value creation of brands which for many companies are the single most important asset. Given the impact and importance of brand assets they should be treated with similar if not more interest and attention than a companies’ tangible asset base. A deeper and clearer understanding of the value creation of brands would benefit investors in selecting their stocks. After all investors rely on the credibility of brands to assure them that the underlying business can deliver the cash flows in the future.

NOTES

1. Tom Koller, Marc Goedhart, David Wessels, 2005, pp. 277–8; Frank Fehle, Susan M. Fournier, Thomas J. Madden and David G.T. Shrider, 2008; T. Madden, F. Fehle and S. Fournier, 2006; Mckinsey, 2004.
2. Best Global Brands, 2009, PricewaterhouseCoopers, 2006; “Brand Leverage,” 1999; Peter Doyle, 2000.
3. The Coca-Cola Company, 2008.
4. Martin Deboo, 2007, pp. 28–31; Morgan Stanley, 1995.
5. David A. Aaker and Robert Jacobson, 1994; “Study Shows Brand-building Pays off for Stockholders,” 1994, p.18.
6. Frank Fehle, Susan M. Fournier, Thomas J. Madden and David G.T. Shrider, 2008; T. Madden, F. Fehle and S. Fournier, 2006.
7. BrandZ, 2009.
8. Natalya Delcoure, 2008; D. Horsky, and P. Swyngedouw, 1987, pp. 320–35.
9. P. Chaney, T. Devinney and R. Winer, 1991, pp. 573–610.
10. David A. Aaker, and R. Jacobson, 2001.
11. David A. Aaker, and R. Jacobson, 1994; S. Moorthy and H. Zhao, 2000, pp. 221–33.
12. I.E. Berger, and A.A. Mitchell, 1989, pp. 269–79.
13. C.J. Cobb-Walgren, C.A. Ruble, and N. Donthu, 1995.
14. Shuba Srinivasan and Dominique M. Hanssens, 2009.
15. Best Global Brands, 2008.
16. “How Analysts View Marketing,” 2005.

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