Goodwill

Out in the financial battlefield right now, there are many acquisitions going on. Well, at least during this period which is already the fifth year of an extended bull market. When one company acquires another, they usually pay a price slightly above the market price or a control premium. When they do that, the acquiror company records the price difference as Goodwill in their accounts. Goodwill is a type of intangible and is depreciable just like property, plants and equipments.

The logic is that goodwill slowly lose its value over time. There are times when this is true and other times when this proves just the opposite. It all depends on the companyacquired and how it is performing for its new parent now. Take Coca-Cola for example. When a company acquires Coca-Cola the company, the company is in fact paying for the 100 years worth of brand-building which Coca-Cola the company has developed since its conception. The premium paid for Coca-Cola which is actually its brand, would be labelled as an Asset in the accounts of the acquiror as Goodwill. In fact, as time passes, the Coca-Cola brand will become even more popular than ever before, as more money will be spent in brand-building.

The worth of Coca-Cola the company can be said to be increasing, instead of decreasing. Yet accounting rules as defined by the AASB requires companies to depreciate Goodwill. This provides an excellent oppportunity for value investors out there to find hidden value in assets where the historical cost in accounting does not truly reflect the true worth of the company. A special mention to Coca-Cola the company which has a truly remarkable brand. It is said that if you travelled to the deepest jungles, enter the most rural village, you still couldn't introduce Coca-Cola to its residents because it is already known there. Studies also support the fact that people continue to drink Coca-Cola no matter what happens. It is very tough for competitors to try and stop their customers from drinking their favourite local drink. It is the brand that allows the company to sell tinted sugar water to customers all over the world who would happily buy them at high high prices.

The opposite can be true about goodwill when the acquiror company paid a silly(high) price for the acquired company who has been underperforming all along. In this case, the goodwill is worth nothing, and would just be another classic example of diworseficiation not diversification. I shall dwelve into that topic in the near future. But currently lets focus on goodwill for a moment. Goodwill will always be an intangible asset, and have to be taken with precaution and care. Remember that when a company liquidates, all that counts is what its assets are worth in a fire-sale. The more commodity-like its assets the higher it sold for. Contrastly, the more specialised its asset the lesser it can be sold for. But goodwill is worth nothing in a liquidation.

When Mr.Market throws a deal at you, remember to check for its goodwill and what it is composed of. Mr.Market is the famous personification of the forces of supply and demand in the sharemarket world, by Benjamin Graham himself. This too is another topic to explore in the future. Goodwill will always come down to the value investor himself(or herself), whether it is truly goodwill or badwill.