'Tis the season, apparently, for goodwill impairment writedowns. And while investors have tended to consider such declarations as earnings-gutting admissions of management missteps, goodwill impairments may actually give cause for rejoice more befitting the season.
Goodwill essentially is the value carried on the books that represents the difference between what a company paid for an acquisition, and what that acquisition's bits and pieces of physical assets could be sold for in the open market. In practical terms, it often represents the premium a buyer has paid above the book value of an acquisition, on the expectation that the money-making potential of the assets far outstrips the sum of its parts.
A study by Goldman Sachs noted that 40 per cent of all goodwill writedowns in the U.S. market are taken in the fourth quarter of each year – no doubt the result of traditional end-of-year corporate navel gazing. And those charges amounted to an oddly wrapped yet very welcome gift for their shareholders.
Looking at goodwill writedowns among S&P 500 and Russell 1000 companies since 2007, Goldman found that companies that booked the biggest goodwill charges – writing off the equivalent of 20 per cent or more of their market capitalization – consistently outperformed their sector benchmarks in the four quarters following the writedown.
Presumably, the market rewards companies that clean up their balance sheets and adopt a more realistic view of the value of their assets. Goldman's research also shows that companies that have persistently high levels of goodwill (more than 40 per cent of total assets), yet don't also outperform their peers on the earnings front, typically show below-average stock returns. If you're going to be a big spender, you had better be a big profit maker, or the market is going to spank you for your impertinence.
The findings are particularly germane given that companies have been loading up on the goodwill over the past decade. Even after the financial crisis and recession crushed asset values and sparked a flurry of writedowns, goodwill has resumed its upward march along with the market recovery. Total goodwill on S&P 500 and Russell 1000 company books was about $2.2-trillion (U.S.) at the end of 2011, more than double its 2002 levels. That amounted to 7.6 per cent of total assets – up a full percentage point from 2002.
That's a lot of intangible value companies have assigned to their books – and an ever-higher hurdle to clear in proving to investors that they can make good on all that value. As the Goldman study shows, investors are more receptive to companies that adjust their values to reflect reality, not hopes and dreams.
David Parkinson