The rise of the intangible economy

- The annual pace of real economic earnings growth has slowed to just 0.7 per cent, down from 8 per cent in the previous eight years.

- Much of this slower growth is also the result of margin improvements rather than sales. Nominal 2018 revenue was in line with 2008 and below the levels of 2011, 2012 and 2013.

- Aggregate 2018 real economic earnings were in line with 2011, and only a fifth higher than in 2007.

Conclusion? That global equities have, in aggregate, essentially gone ex-growth.

The grouping includes some of the largest companies and has a combined market capitalisation of $16.9tn.

Broadening the universe to Croci’s full coverage of 900 companies (70 per cent by weight of the MSCI ACWI index, which tracks global stocks) changes the picture little, with earnings growth rising to only 1.4 per cent.

This stagnation presents a genuine challenge for investors.

The result is that, overall, equity valuations are high, and the earnings growth that could justify these valuations seem structurally impaired.

Asset-light companies have delivered higher earnings growth

A closer look at growth by sector reveals an interesting picture.

The weakness is not uniform — some sectors (IT and healthcare, for example) have managed to deliver strong earnings growth, while others have lagged.

What is more, the sectors that have generated growth fall into the ‘asset-light’ category, requiring lower tangible capital investments than the average company to generate revenues and earnings.

By comparison, the sectors that have delivered negative growth since 2007 are all ‘asset-rich’, requiring large physical capital investments.

These results, again, point towards a fundamental change, with earnings growth now dependent more on knowhow and brand names rather than tangible capital.

And when you think about it, this makes sense.

The big earnings generators today do not need vast machinery, or capital intensive industrial plants to generate profits. 

Share price moves follow

Figure 1 shows how, at an aggregate level, only companies with intellectual capital have been able to grow their earnings since 2007.

Figure 1: Earnings growth has come from companies with intellectual capital

Source: DWS, Croci. Data as available on March 1 2019.

What is more, the higher earnings growth is not down to a few large companies driving the performance of one group, or because of exposure to specific sectors, as Figures 2 and 3 show (the rise of the intangible economy is not, therefore, just a few big internet companies phenomenon – it is wider than that).

Figure 2: Median earnings growth - global coverage