Investing in the Age of AI: Why Intangible Assets Matter More Than Ever

The traditional rulebook for evaluating companies is becoming obsolete. Today’s most valuable corporate assets are invisible – they exist in lines of code, neural networks, and the collective knowledge of technical teams. While balance sheets excel at capturing the worth of factories and equipment, they fail to reflect the true value of artificial intelligence (“AI”) capabilities that increasingly drive corporate success.

The Art of Valuation in the Age of AI

Traditional manufacturers, with their tangible assets of plants and machinery, often trade near book value. Their worth is readily apparent – you can walk through their facilities and touch their assets. Yet many of today’s most valuable companies, those heavily invested in AI, command valuations at 15 times book value or higher. Their true worth resides in assets you cannot see:

• Sophisticated algorithms that improve with each interaction
• Vast databases that feed machine learning systems
• Research teams pushing the boundaries of AI capabilities
• Network effects that create exponential value as user bases grow

This fundamental shift demands a new valuation framework. Applying traditional metrics designed for industrial-era companies to AI-driven enterprises misses crucial value drivers.

At Bridgeway Capital Management, our Absolute Return stock selection models recognize that effective investment analysis must be contextual – adapting our process to understand how value is created differently across sectors in this new AI-driven economy.

Why Traditional Accounting Misses the Mark

Financial statements systematically understate both earnings and book value when companies invest heavily in intangibles, including, but not limited to AI:

Earnings Distortion:

• Research and  development (“R&D”) expenses are immediately written off rather than capitalized and amortized
• Training and workforce development costs reduce current earnings despite creating future value
• Marketing spending to build brand value appears as an expense despite building lasting customer relationships

Cash Flow Complications:

• High initial investment periods show negative free cash flow despite building valuable capabilities
• Traditional free cash flow metrics don’t distinguish between investment in growth versus maintenance
• Working capital metrics fail to capture investment in data and intellectual property

Book Value Understated:

• Successfully developed internal software has zero book value
• Accumulated organizational knowledge shows as zero on balance sheets
• Brand value built through marketing appears nowhere in assets

Real-World Impact Across Industries

Software/Tech:

• Google’s AI language models like BERT and LaMDA require massive R&D investment that appears as pure expense, despite creating foundational technology that powers multiple revenue streams
• TikTok’s recommendation algorithm development costs are expensed immediately, yet this AI system drives unprecedented user engagement and advertising value
• NVIDIA’s AI software development appears as current expense despite creating lasting competitive advantages in AI acceleration

Media/Entertainment:

• Disney’s investment in AI-powered content recommendation and production tools shows as cost despite enhancing streaming engagement
• Netflix’s spending on AI for personalization and content optimization reduces current earnings but builds valuable predictive capabilities
• Meta’s AI content moderation system development appears as expense despite creating platform value

Retail:

• Costco’s AI inventory management and demand forecasting investments reduce reported profits while building lasting efficiency gains
• Nike’s AI-driven design and customization platform development costs mask future revenue potential
• Amazon’s robotics and AI logistics investments appear as expenses despite creating powerful automated fulfillment capabilities

The Bridgeway Advantage

We believe a few advantages of our Absolute Return contextual stock selection based on intangible capital intensity include:

1. Emphasizes valuation metric relevancy based on intangible intensity
2. Recognizes how R&D and human capital are valued differently across industries
3. Adjusts for different sentiment and profitability patterns across sectors
4. Identifies irrational exuberance in AI-driven business models

In an era where the most valuable assets are invisible, you need an investment approach that sees the full picture. That’s the Bridgeway difference.

Additional Readings

• Dugar, A., & Pozharny, J. (2021). Equity investing in the age of intangibles. Financial Analyst Journal, March 2021.[Equity Investing in the Age of Intangibles | CFA Institute Research and Policy Center]
• Berkin, A. L., Dugar, A., & Pozharny, J. (2022). The impact of intangible capital on factor performance efficacy. Journal of Portfolio Management, July 2022. [The Impact of Intangible Capital on Factor Performance Efficacy | Portfolio Management Research]
• Berkin, A. L., Dugar, A., & Pozharny, J. (2024). Classical stock valuation in the modern era of intangibles. Journal of Investing, June 2024. [Classical Stock Valuation in the Modern Era of Intangibles | Portfolio Management Research]