Goodwill

We have discussed in the past how excessive intangible assets such as goodwill can derail a business. Goodwill results from acquisitions that occur above a company’s book value. Recent examples of goodwill headaches include Kraft Heinz and GE. These companies are not the only culprits of bad goodwill as S&P 500 companies had $3.3 trillion of goodwill at the end of 2018. This was equal to approximately 10% of total assets and does not include other intangible assets which can be hard to value. While the surge in goodwill is concerning, not all goodwill is bad as some companies are able to seamlessly integrate the business which drives synergies and increases profits. Disney is a prime example of a company that has been able to derive tremendous value from companies it has acquired such as Marvel and Lucasfilm. Unsuccessful acquisitions result in bad goodwill which can lead to major write downs on a company’s balance sheet. This creates negative earnings, reduced equity, and an increased debt/equity ratio. Distinguishing between good goodwill and bad goodwill could mean a big difference in stock price gains. My recommendation is to be cautious of companies with high goodwill and research the acquisitions closely. One thing we do to help avoid bad goodwill is look at the company’s Return on Assets (ROA). If the company is unable to generate a good ROA, there is a high likelihood the goodwill is not performing up to the purchase price.