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Human Capital move stock prices

I went to a very interesting event in London a few weeks ago. It was arranged by Human Potential Accounting and the event was titled The Future of
Investment: Human Capital. A panel composed of people from different parts of the investment community private equity, regulators, pension funds,
investment banks etc. discussed how much they use Human Capital when assessing the value of companies. The topic is ever relevant and
interesting.
When I think back upon my time as financial analyst in London, I remember that a lot of our valuations was based upon gut feeling. This gut feeling
(should PE be 15x or 17x) had a great impact on valuations and much of it came down to Human Capital. It was soft, people stuff such as ability to
execute, trust in management, aligned organization, ability to change and ability to innovate. I never tried to put an exact value on these things, but
I would write things such as I do not believe the management will be able to deliver on this strategy or something like that.
About 80% of the market value of a stock is not accounted for by the tangible assets on the balance sheet. In the early 80s this figure was closer to
40%. So clearly the intangible value matters more today that they did 30 years ago. Human Capital is without doubt one of the most important
intangible assets.
So when people ask is Human Capital actively used in valuing stocks today the answer is both yes and no. No, I never see an explicit value put on
any parts of Human Capital and it is never capitalised on the balance sheet. But yes, people issues matters a lot when investors, analysts and
companies assess the market value of a company.
Human Capital in Financial Statements
Looking through financial statements today it is clear that there is a huge gap between what companies say are their most important asset people
and what they report in their financial statement tangible assets, products etc. Financial regulators such as SEC and FSA as well as stock
exchanges are not much better. They demand certain items to be in the financial statements but not one demand information about people. This is
amazing when you consider that more than 80% of the market value of the average S&P500 company is intangible assets i.e. above the book value of
a company.
I think a major reason has to do with the fact that no credible standard has been put forward. If a company wanted to show the value of their software
developers, sales people and marketing departments as well as receptionists and top managers how should they account for this? By number of
people? By total cost of the people? And how do you show investments into this asset base and what about depreciation of it? Does CROIC (Cash
Return On Invested Capital) make sense for people or do we need completely new metrics? I just dont think they know.
Luckily a bunch of really good initiatives are underway to try to come up with standards for accounting for people. An interesting White Paper about this
topic can be downloaded here: http://hcminst.com/articles/
I believe it is very important to come up with global standards for financial accountability of human capital. Today it is impossible for investors to have
any feel for the quality of software developers at company X compared to company Y. The financial accounts today simply does not begin to describe
this important asset base. How should investors and owners understand what they have invested in?
The Value of Human Capital: Measuring Your
Most Important Assets

Chuck Leddy
More by Chuck
JULY 18, 2016
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Assessing the value of human capital (HC), the most important asset of any organization, has long been easier said
than done. Because it is such an intangible asset, assigning a value on a balance sheet is a perennial challenge.
There are no generally accepted standards for measuring the value of people, unlike the readily available tools for
quantifying the value of tangible assets such as equipment, office furniture or accounts receivables.

Standard Human Capital Valuation Metrics Remain Lacking

As human capital management has come to the forefront of today's innovation-driven, talent-driven and knowledge-
based economy, and as smart organizations make huge investments in developing their people, CFOs struggle with
measuring the return on their human capital investments. CFOs certainly recognize the truth of that ancient, much-
parroted truism, "people are our most valuable asset," and invest in HCM accordingly, but they don't have standard
metrics to assign a value to the people they are investing in.

The CFO of iRobot explained the HC valuation problem in an article for CFO Magazine, "It's a fair point that the
balance sheet doesn't recognize the value of human capital, and certainly not the full value of your intellectual
property. For a high-growth technology company like ours, there is significant intrinsic value in the know-how and
innovation of our people, which is why we've traded over the last couple of years at a fairly attractive multiple."

But understanding your HC's perceived value is still more guesswork than most numbers-driven CFOs would like.

Tangible and Intangible Assets

Not knowing the value of something can create obvious problems. So while your business has metrics to measure its
other most important indicators, such as sales revenues and production costs, ironically, there are few standard
measurement metrics for the most important drivers of business success.
You can estimate and report the value of your organization's patents, trademarks and other forms of intellectual
property. It's not always easy, or without the possibility interpretational differences, but it's possible to determine the
value of those intangible assets. So if you can decipher the value of human capital's intellectual creations
(innovations), why is it so much harder to determine the value of a great engineer who can drive innovation or a great
leader who can inspire entire organizations?

According to a CFO Research Services report, nearly all CFOs recognize the critical impact of human capital in key
business areas such as driving customer satisfaction, product/service innovation, growth and overall profitability.
Despite their clear agreement on the importance of human capital for business success, and their continued
willingness to invest resources in developing their people, only 16 percent of surveyed CFOs reported feeling that
they truly understood the return on their human capital investments. When any group of investors does't understand
their return on investment, but invest generously nonetheless, there's clearly a need for standardized metrics.

Luckily, help may be on the way.

HCM Metrics to the Rescue?

CFOs and CHROs will need to combine forces to introduce HC valuation metrics and HC reporting standards that are
truly representative of your organization. As an article in Strategic Finance Magazine points out: "to be truly valuable,
human capital analytics and metrics need links to business results and reinforcement through compensation,
communications, training, and ongoing reporting. This is an area where collaboration between the CFO and CHRO
can create strategic value within an organization."

For example, the Human Capital Management Institute (HCMI) has developed a number of HC reporting tools called
Human Capital Financial Statements to express the value of human capital in various ways. One such tool is called
the Human Capital Impact Statement, which the HCMI says "quantifies the workforce impact on financial results.
Using the Human Capital Impact Statement, organizations can build and show a business case and quantify the
impact of HR, as well as assess historical and projected future impacts of workforce decisions and changes upon the
organization's financial results."

While it's clear that more tools are becoming available, such as ongoing initiatives from the Society for Human
Resource Management (SHRM) to develop Human Resource Management Standards, much work remains to be
done before CFOs will have internationally accepted human capital reporting standards. Nevertheless, people will
remain your organization's most critical components. It should, therefore, continue to be a major priority to investigate
and incorporate methods to assess just how valuable those people are to your organization's continued success.

July 18, 2016