The Power of Branding

If Shakespeare were writing today, he probably would leave out the lines:

"What's in a name? That which we call a rose /
By any other name would smell as sweet."

Why? Because studies have shown that, in all probability, sticking that rose in a Coca-Cola can or a McDonald's wrapper would really make people perceive it as smelling that much sweeter.

A brand is more than a name—it is the sum total of a consumer's experiences with a recognizable product—and it is powerful, often leading to a competitive advantage. It is also frustratingly hard for investors to value.

The Elite List

Every year, Interbrand releases a list ranking the best global brands. This list reads like a who's who of the financial world and contains many of the companies making up the famous Dow Jones Industrial Average (DJIA). However, you don't need to be a disciple of the Dow to recognize the brands; these are some of the most recognizable symbols in the world. Is being well-known valuable to a company? It sure is.

Here are some examples where branding has been the difference for companies:

• Marlboro Friday: Phillip Morris, the inventor of cowboys, smoking, and smoking cowboys, was facing increased competition in the cigarette industry in the 1990s. When the company cut the prices of its heavily-branded cigarettes, investors pushed the panic button and drove the stock down 26% in a single day. Despite a decline in smoking rates, the Phillip Morris brand won back consumers at a lower price and re-established its dominance.
• New Coke: In a textbook illustration of what not to do, Coca-Cola found itself competing against its own brand and lost badly. Coca-Cola was worried about upstart Pepsi eroding its domestic market share and decided to shift production to a new formula: New Coke. In doing so, they halted the production of the original Coca-Cola—an extremely profitable product they had been making for over a century. The backlash was so great New Coke was scuttled within months and Coca-Cola Classic re-entered the market. 
• Apple: The 1990s saw computers getting faster, better, and, most importantly, cheaper. Microsoft was making billions by providing operating systems on all of these machines. Apple was making expensive machines and, as the company's struggles showed, nobody wanted expensive computers when cheap would do. In 1997, Steve Jobs returned to Apple with the novel idea of making even more expensive computers. The difference was Jobs redoubled Apple's branding efforts, culminating in the "PC vs. Mac" campaign. Apple still makes really expensive machines, but it has gotten a lot better at making people want them.

How to Value a Brand

Although we can see brands are valuable to a company, brands are still considered among the intangible assets. Investors have tried many ways to separate the brand from the balance sheet to come up with a number. There are three main approaches that have gained traction. 

1. Stripping Out Assets

The easiest way to put a value on a brand is to calculate the brand equity of a company. This is a simple calculation where you take a firm's enterprise value and subtract the tangible assets and intangible assets that can be identified, such as patents. The number you are left with is the value of the company's brand equity. The obvious flaw is that it doesn't take revenue growth into account, but it can provide a nice snapshot of how much of a company's value is goodwill.

2. Product to Product

Another way investors try to account for a brand is to focus on the pricing power of a company. Simply put, they want to know how much of a premium the company can charge above its competitor's product. This premium can then be multiplied by the units sold to give the annual figure for how much the brand is worth.

3. The Intensive Approach

Although too time-consuming to be practical for individual investors, the methodology behind Interbrand's ranking is the most complete. By incorporating similar approaches to the ones above and combining them with proprietary measures of brand strength and the role of the brand in consumer decisions, Interbrand provides a holistic measure of brand equity for the companies it measures. Unfortunately, Interbrand doesn't offer a free analysis of all the companies investors want to know about.

Double-Edged Intangibles

Whether you ballpark it or dig down to a more specific number, most investors are happy to have brand equity on their side. Surely the branding edge of Coca-Cola was one of the economic moats Warren Buffett talks about. However, brands can cut both ways.

Although it is intangible, it is more than possible for a company to destroy or tarnish its brand equity. By jokingly calling his company's jewelry "total crap," CEO Gerald Ratner badly damaged the image of Ratners. In addition to losing market value, the company renamed itself Signet to distance itself from the disgraced Ratner brand.

The Bottom Line

Ratner's is a tale of caution for investors who are already paying a premium because of brand equity. Brands are fickle beasts that can be hard to nurture and easy to kill.

That said, a solid brand and the pricing premium it brings can be very attractive to investors, and with good reason. The power of branding can help a company triumph in a price war, thrive in a recession, or simply grow operating margins and create shareholder value.

Like the brand itself, the premium investors are willing to pay for the stock with a branding edge is almost entirely a psychological choice. A stock with a large amount of brand equity is, of course, always "worth" whatever someone is willing to buy it for.