It’s not just hype, it’s accounting.
Many tech companies appear expensive when judged by traditional valuation metrics like the price-to-earnings (P/E) ratio. But beneath those seemingly high multiples lies a key insight: the accounting treatment of intangible investments.
Intangibles vs. Tangibles: What’s the Difference?
Companies that invest heavily in intangible assets – such as R&D, software development, brand building, and customer acquisition, typically trade at higher multiples of earnings and book value than firms focused on tangible assets like factories or equipment.
The reason is straightforward: intangible investments don’t appear on the balance sheet the way tangible assets do. Instead of being capitalized, they’re usually expensed immediately through the income statement. This accounting treatment can significantly understate a company’s true earnings power and asset base.
A Case in Point: Apple
Robert Hagstrom, in The Warren Buffett Way, highlights Apple as a perfect example, citing research by Michael Mauboussin. Apple invests approximately $30 billion annually in intangible assets, including product development, software, and ecosystem growth.
Here’s how this affects reported earnings:
- In 2024, Apple was expected to earn $95 billion, or $6 per share.
- With its share price at the end of 2023, this gave Apple a P/E ratio of 31x, well above the S&P 500 average of 20x.
But what if Apple’s intangible investments were capitalized like tangible assets?
- If those $30 billion were capitalized (and not expensed), Apple’s adjusted earnings would rise to $125 billion, or $8 per share, implying a P/E ratio of just 23x.
- Even using a more conservative approach – depreciating intangibles over five years, Apple’s adjusted earnings would be $119 billion, or $7.62 per share.
- That would bring its P/E ratio down to 24x, making it far more comparable to peers.
Why This Matters
Mauboussin’s key insight: industries vary greatly in their mix of intangible and tangible investments, and that mix dramatically affects reported profitability. Tech and consumer platforms (like Apple, Meta, Google) appear expensive on the surface, but often generate far more intrinsic value than the accounts suggest.
The Takeaway for Investors
When comparing P/E ratios across sectors, not all earnings are created equal. In intangible-heavy businesses, the reported net income can be artificially low due to accounting conventions, not economic weakness. As a result, these companies look expensive — but often aren’t.
Understanding how intangibles affect earnings helps investors make better, apples-to-apples comparisons. In a digital-first world, recognizing this accounting blind spot is a key to identifying true value.