My experience reading notes to financial statements about goodwill and intangibles has made me a lazy investor:
I simply cannot be bothered with the legwork of placing a value on goodwill and intangibles when so much of it is make believe, especially when you consider the concept of goodwill from our good friends at Wikipedia:
“Goodwill is an accounting concept meaning the value of an entity over and above the value of its assets”
‘Over and above the value of its assets’.
Why would you want to pay for something over and above the value of its assets?
What this jargon means is that when one company buys another company and pays more than the book value, the difference between the book value and the purchase price is entered onto the purchasing company’s balance sheet as goodwill.
This ‘premium’ paid above book value for a company is goodwill and classified as an asset.
This is of course nonsense.
How can an overpayment be an asset, unless of course the meaning of the word asset has changed to rip-off or something such as ‘you have handsomely paid way over the odds for companies that you have acquired’.
Goodwill and intangibles. Laurel and Hardy. Tom and Jerry. They all have comedy value. The sky really is the limit (hence the hot air balloon) when it comes to goodwill and intangibles.
What is more interesting is that there are analysts far cleverer than me who will pick apart goodwill and intangibles to arrive at a value (?) for goodwill and intangibles based upon their analysis.
Goodwill And Intangibles…More Accounting Gimmickry
Goodwill can arise from other sources. One example is if a company has a strong brand name.
Companies are allowed under current accounting laws to place a value on this ‘brand identity’ and place it as an asset on their balance sheet under goodwill and intangibles.
Newer readers may find it strange that a brand name can have a monetary value placed upon it at the discretion of the management of the company.
problem question that arises for investors is: How do you value a brand name? $1million, $100 million, $1billion, $100 billion?
In much the same way that the difference between book value and the amount paid for an acquired company (thin air) can be called an asset, valuing a brand name is a silly exercise in the majority of cases, at least for me.
There are investors who will place a value on brand names and enter them into their calculation of book value, but that is not the Graham/Schloss way.
How Ben Graham And Walter Schloss Dealt With Goodwill And Intangibles
Ben Graham placed a zero value on goodwill and intangibles as did Walter Schloss when calculating book value.
Graham viewed goodwill as a tool with which managements are able to increase or decrease the value of their assets from thin air.
Intangibles are for all intents and purposes the same as goodwill insofar as they represent items on the balance sheet that you cannot ‘feel’ or ‘touch’.
For example cash is tangible because a £50 note will have a value of £50 whenever I take it to a shop or the bank. There is a clear value to a £50 note.
A patent (an example of an intangible asset) protects the inventor of a new invention from his or her work from being copied or used by others.
It is intangible and cannot be accurately ‘valued’; it does not have a monetary value that can be reasonably agreed upon. Whereas £50 will always be worth £50.
A company like Coca Cola does have an advantage over other cola producing companies because of it’s brand name. The trouble comes in trying to accurately identify the monetary value of such an advantage.
To avoid trouble and adhere to a more rational valuation process, goodwill and intangibles are simply removed from the calculation of book value. This is has become a feature of the analysis process at The Shares And Stock Markets Blog.
The next step
For a real world illustration of goodwill and intangibles, I will take a look at some balance sheets and the notes to the accounts that explain goodwill and intangibles in part 2.
This way I can show you exactly why goodwill and intangibles have no value for me as a follower of Ben Graham’s and Walter Schloss’ investing principles.
Thanks for reading The Shares And Stock Markets Blog. Good luck with your investments.