Management Accounting

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Financial Accounting

Case Study: ARM Holdings Plc

Stock Market Value vs. Visible Equity

The Tech Market Amplification

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Lex Bradshaw-Zanger

January 2003
Stock Market Value vs. Visible Equity – The Tech Market Amplification

Introduction

How do we place a value on knowledge? In fast-growing sectors like biotechnology and computer software, including some parts of GIS (Geographic Information Systems), a large part of the value of the company resides in the knowledge embodied in its patents and in its staff. Sveiby (1997) pointed out the huge growth in the difference between Sun’s stock market value and its book value in 1995±96 because of the announcement of Java; this represented a major increase in its intangible assets. He categorised the different types of intangible assets as below.

| |Intangible Assets (stock price premium) | |Visible Equity |External Structure |Internal Structure |Individual | |(book value) | | | | | |Brand, customer and |The organization: |Competence | |Tangible assets |supplier relations |management, legal |Education, | |minus visible debt | |structure, manual |experience | | | |systems, attitudes, | | | | |R&D, software | |

The prolonged rise in stock prices from 1993-2000, fuelled by rapid development of technology, was an extraordinary period for large capitalisation growth stocks. During this same period the surge in the development of new computer and communication technology, and a speculative market in internet and technology related stocks approached a feeding frenzy before the bubble burst in the first quarter of 2000. The combination drove the stock market to record valuation levels, as measured by traditional valuation ratios for the S&P 500, just as the economy was also nearing the end of a long and moderate expansion. Even after a significant price correction during the bear market of the past two years, the S&P 500 remains in a very high valuation range, roughly 3 standard deviations above its long-term median.

In 2001 the economy entered a cyclical downturn after 7 years of moderate growth. That downturn, however, was somewhat exacerbated by the collapse of the internet/technology bubble, which wiped out huge paper gains for many investors, put thousands of people out of work, and brought to a close an unusually prosperous era for the brokerage and investment banking community. After two decades of compound annual returns in excess of 17% per year, by the beginning of 2000 widespread support by investors had developed for the concept of a ‘New Paradigm’ era, in which old measures of value were no longer relevant. A new era of productivity and growth had dawned, supported by the modern miracle of the Internet. Globalisation would assure prosperity for years to come, and if stock prices dropped from time to time, why the obvious thing to do was to buy on the dips; there was a widespread belief that investors could earn returns of 15% per year over the long term. Day trading and investing was at an all time high and nothing was free from this ever rising bubble. “A number of lower quality stocks ... had simply become caught up in the frenzy and were clearly overvalued.”[1]

The ‘new paradigm’ looks pretty silly today, but just over two years ago it was the prevailing view. Now the pendulum seems to have swung the other way. There are many clear reasons why we can no longer expect good returns from common stocks. The risk premium has disappeared. Valuations are so high...
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