Wednesday, October 16, 2024

Are Royalties a Good Investment?

Royalties—those often-overlooked cash flow machines—are starting to catch the eye of savvy investors. Why? They offer something increasingly rare in a world of volatile stocks and trendy crypto: predictability. Yes, royalties, whether from natural resources, music, film, patents, or literary works, provide a steady, measurable income stream that can outlast market swings and economic uncertainty. But before you dive headfirst into the world of intellectual property (IP) investments, let’s have a look at what makes these earnings tick and, more importantly, how to ensure you’re getting your money’s worth.


The Allure of Predictability

What sets royalties apart from your typical high-risk, high-reward investments? Stability. You’re not guessing which tech stock might moon next year; you’re buying into a pre-existing revenue stream. For example, if you purchase the rights to a well-established song or a blockbuster movie, you’re effectively buying a forecastable flow of income based on historical data. There’s no speculative frenzy here, just cold, hard numbers.

Sounds great, right? But the key is not just in buying any royalty stream; it’s in buying the right one. That’s where a bit of accounting magic comes into play—evaluating the quality of earnings and ensuring that what looks predictable on paper holds up under scrutiny.

Quality of Earnings: No Rose-Colored Glasses Allowed

You don’t want to end up owning the rights to some obscure garage band’s forgotten track, right? What you’re looking for is a revenue stream with staying power. This means evaluating earnings quality with a fine-tooth comb. Are the earnings from this royalty stream recurring, and if so, for how long? Are there any licensing agreements in place that guarantee future payments? How does the IP perform across various platforms—streaming, digital purchases, physical sales? What are the risks and liabilities associated with the rights to be acquired (e.g., copyright grant termination claims, AI reducing demand for original works).

If the royalty stream depends too heavily on one platform or licensing agreement, you might be setting yourself up for a dip in income when trends shift. Diversification matters even in this niche corner of finance.

How to Price a Royalty Stream: It’s All About the Numbers

So, you’ve got your eye on a royalty stream. How do you know if it’s worth the price tag? Enter: discounted cash flow (DCF) analysis. This isn’t the part where we get romantic; it’s where we get real. The value of a royalty is in its future cash flows, and we can calculate its intrinsic value based on those cash flows over time.

DCF methodology involves estimating the future income from royalties and discounting it back to its present value. In layman’s terms, you’re asking: “How much is this steady income worth to me today, considering future inflation and risks?” Sure, it’s a bit of financial alchemy, but with the right approach, it’s surprisingly straightforward. And the beauty of royalties is that, in many cases, these future income streams are more predictable than other assets.

Comparing Royalty Investments to Other Passive Income Streams

When stacked against other passive income opportunities—like dividend-paying stocks or real estate investments—royalties have their distinct advantages. First, they tend to be uncorrelated with the stock market. That means your royalty income isn’t going to take a nosedive just because the S&P 500 does. Second, they can be relatively low-maintenance. You’re not dealing with tenants, property taxes, or quarterly reports; you’re collecting checks from IP that’s already in use.

The key difference is that royalties aren’t a gamble—they’re an investment in a stream of predictable, recurring earnings. But that doesn’t mean they’re risk-free. You still need to evaluate their longevity and ensure that you’re not overpaying for a stream that’s past its prime.

So, Are Royalties a Good Investment?

In a word: yes—but only if you’re willing to do the homework. The predictability of royalties is their biggest asset, but it’s your job to ensure that predictability holds up. You’ll want to dig into the quality of earnings and evaluate the intrinsic value using sound methodologies like discounted cash flow.

Royalties can offer a stable, passive income stream that outperforms other investments in times of uncertainty, but as with anything in life, success depends on selecting the right ones. Do that, and you might just find yourself with a long-term investment that pays out like clockwork, no crown required.

At our firm, Boschan Corp., we can help you ascertain quality of earnings and intrinsic values during the due diligence process. Call us today at 424-248-8866 to run a conflict check and see if we can provide you with clarity and certainty in your royalty investment strategy.