Stocks may be pretty high, or they may still be cheap

The Economy

October 17, 1999|By William Patalon III

WE'VE ALL heard the doomsaying prophesiers who warn that stocks are dangerously overpriced.

But those gloom-and-doomers may have it wrong. Indeed, such experts as consultant Ken Standfield believe that stocks are downright cheap.

"We are finding the reverse may actually be true -- that the stock market is actually undervalued," says Standfield, a director of KNOWCORP Inc., a Melbourne, Australia, firm that helps companies harvest their intellectual wealth and boost their stock prices.

Bullish-brethren members increasingly focus on one point in concluding that stocks are cheap: Financial accounting rules assign no paper value to "intellectual capital" -- the patents and technological know-how that nearly always decides the winners in today's global-economy.

Trouble is, as the economy evolved from steel to semiconductors, the accounting system lagged, says Jim Seymour, a technology-finance expert and columnist for TheStreet.com, the online financial daily.

"Our accounting system is archaic," says Seymour, chief executive officer of the Seymour Group Inc., in Austin, Texas. "It fails to put a dollar value on the patents, trade secrets, brands and franchises that are clearly very substantial in value."

Finding a credible means of quantifying technological proficiencies "is becoming the hottest topic in financial circles," says Dan Noll, technical manager for accounting standards for the American Institute of Certified Public Accountants in New York City.

"Certainly, we're hearing from financial-statement users [such as investors] who say they would like to have something to use," Noll says. "The question is: `How do you do it?' "

It's a significant economic issue and can determine whether employers may innovate and grow, and can decide whether personal coffers grow or shrink.

Here's one reason. By failing to formally acknowledge the worth of intellectual capital, finance experts say, we drastically understate the paper -- or "book" -- value of our companies, crimping stock gains.

Investors very often compare a company's "book value" to its "market value" -- the high-dollar figure received by multiplying the corporation's stock price by the total number of shares it has outstanding. A company's market value is nearly always higher than its value "on the books." Indeed, with a technology company such as Microsoft Corp., the gap between the stated worth on paper and the value in the marketplace is typically vast. Even so, if that gulf widens into a great chasm, investors get nervous.

There's a second argument for quantifying "intangible assets." By treating them as investments, rather than expenses, corporations wouldn't have to write off the costs all at once, profits would actually increase, and stocks would be accurately priced and yet appear cheaper, according to a recent Lehman Bros. report.

This hole in the accounting system penalizes us in several ways, according to analysts and economists. First, this shortcoming probably holds stock prices below their true worth, since companies appear less valuable on paper than they actually are, says David Elias, a finance author and president of Elias Asset Management, an investment firm near Buffalo, N.Y., that manages $700 million.

"Intellectual capital is there," says Elias, whose newest book says the Dow Jones industrial average should eclipse 40,000 by 2016. "You can't touch it; you can't taste it; you can't smell it. But it's there."

The toll may be worse during uncertain stretches -- such as now.

For sure, investors are catching onto these flaws in our accounting rules, which is why stock valuations relative to profits and book value remain above historical norms.

Even so, investors are easily rattled and are quick to dump "pricey" stocks just as they did on several days last week.

Such knee-jerk sell-offs make the economy vulnerable to a stumble, since stock market wealth has become so important to the country's vitality. Thanks to the long bull market, consumers have felt flush enough to dole out dollars for clothes, electronic gizmos, cars and houses -- key since all that spending accounts for 70 percent of U.S. growth.

And, with inflation and interest rates still low, the nation seemingly awash in cash, and excitement high over the technologies and stock-price run-ups of Internet upstarts, America's capital-hungry technology firms have found essential cash to be both cheap and easy to come by.

But several studies show that, as technology expands into a bigger and bigger piece of our economy, there's an urgency to place price tags on our intellectual inventory.

In terms of market value, technology shares have climbed from 7 percent of the benchmark Standard & Poor's 500 index in 1992 to 25 percent today, according to a second Lehman Bros. report. Likewise, intangible [unquantified] assets have risen from about 38 percent of a company's market value in 1982 to as much as 90 percent today, the International Federation of Accountants said in July.

Thanks to its intellectual capital, "America owns the future," says Elias. But for America to stay at the head of the table, securities-industry insiders say, that resource has to be put on the books.

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