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The brand is the most valuable asset at most companies. It is also the most difficult asset to hang a dollar sign on. With intangible assets accounting for as much as 80% of market value of the S&P 500, being able to forecast the value of brands is essential to investors. To deal with this problem, a variety of approaches have been developed. There is no single authoritative and valid approach to calculating the value of a brand. In fact, most valuation models encourage companies to inflate the relative importance of their brands. A game most corporations are more than happy to play.

Everybody's Above Average
Brand equity and CEO compensation are often set by a method called peer benchmarking. Corporations look at the acquired goodwill assessments of competitors in the same industry and use these valuations as a model to create an industry average. After careful consideration, the company inevitably comes to the conclusion that their brands are superior to the category average and assess themselves a premium valuation. This process is emulated in turn at all of the competing companies, resulting in an upward spiral in brand equity valuations.

We see this idea in action all the time in stock markets. For example, after Johnson and Johnson (NYSE:JNJ) announced its intention to acquire Crucell, we saw an immediate upward re-evaluation of vaccine producers based on implied comparability.

Price Premium Method
Extrapolating on the idea that the value of a brand resides in its ability to bias customer choice. The value of a brand can be loosely written as:

Brand Value = { (V/S)b - (V/S)g } * Sales

(V/S)b = Enterprise Value / Sales ratio of the firm with the benefit of the brand name
(V/S)g = Enterprise Value / Sales ratio of the firm with the generic product

Let's use as an example branded cereals maker like Kellogg (NYSE:K) against a generic provider like Ralcorp (NYSE:RAH).

Value of Kellogg brand name = (1.78 - 1.32)(13846) = 6369 Million
Thus, (6369/24200) or 26% of the value of the company is derived from brand equity.

This method is flawed because the primary purpose of many brands is not necessarily to obtain a price premium but rather to secure the highest level of future demand. The value added of these brands lies in securing future volumes rather than securing a premium price. This is true for many durable and non-durable consumer goods categories.

Today, everything is branded, and there are rarely generic equivalents adequate for comparison. Even private label brands, like Kirklands (NASDAQ:KIRK), have an intangible value. The price premium can be an indicator of a brands strength, but it is not the only value added contribution brands confer.

Royalty Relief Approach
Royalty Relief defines the value of the brand in relation to the royalty rate that would be payable for its use were it owned by a third party. The method involves estimating likely future sales, applying an appropriate royalty rate to them and then discounting estimated future royalties, to arrive at a Net Present Value. This is held to represent the brand value. The Royalty Relief approach, also called economic use, has become the most widely recognized and accepted method for brand valuation. This is the method used by the likes of Interbrand to calculate that the Coca-Cola (NYSE:KO) brand is worth $72 Billion.

This method invariably results in double-counting the value of the brand. Let's assume that the future sales of the brand in question are calculated using a discounted cash flow model. This value already incorporates the value of the brand through the premium growth rate. In other words, by estimating future sales you are already implying a value for the brand in question. If an additional value is now assigned separately to the brand name, the brand value is being double-counted.

Conclusion
Brand equity is one of the few assets that can provide a long-term competitive advantage. In spite of the undeniable importance of brands, there is no reliable method of quantifying their value. Current models encourage the steady inflation of brand valuations. The result is that intangible assets now count for the vast majority of stock market valuations. If current accounting principles were to be called into question it could result in a major loss of asset values. Although brand value may be abstract, it is still the single most important thing about most stocks.

"If this business were split up, I would give you the land and bricks and mortar, and I would take the brands and trade marks, and I would fare better than you."
- John Stuart, Chairman of Quaker (ca. 1900)

Sources

  1. www.oceantomo.com/media/newsreleases/Int...-Study
  2. www.brandchannel.com/papers_review.asp?sp_id=357
  3. www.managementparadise.com/forums/market....html
  4. 4-traders.com
  5. en.wikipedia.org/wiki/Brand_Finance
  6. www.interbrand.com/en/best-global-brands....aspx
Source: Can You Calculate Brand Value?