The most charitable interpretation of goodwill is that it
measurestheestimatedvalueofgrowthassetsin thetarget
company; growth assets are investments that the target
companyisexpectedtomakeinthefuture.Thisistrueonlyif
afairpriceispaidontheacquisitionandthebookvalueof
thetarget companymeasuresthemarketvalue ofassetsin
place,bothofwhicharedauntingassumptions.Inreality,the
value of goodwill will be affected by:
- Mismeasurementofbookvalue.Ifthebookvalueof
assetsisunderstatedbecauseofaccountingchoices,
thevalueofgoodwillwillbeoverstated,andifbook
value is overstated, goodwill will be understated. - Overpaymentorunderpaymentonacquisition.Ifthe
acquiring company overpays on an acquisition, its
goodwill will increase by the overpayment. If it
underpays, the reverse will occur.
Thoughthismaybeaskingfortoomuch,ourjobinvaluation
wouldbemadefarsimplerifthegoodwillitemonbalance
sheetswerebrokendownintosmartandstupidcomponents,
withtheformerbeingforgrowthassets(andthusjustifiable)
and the latter capturing the overpayment on acquisitions.
Whencomputingthereturnoninvestedcapital,whereweare
oftencalledupontoestimatethereturnonassetsinplace,we
wouldtreatthestupidgoodwillaspartofthecapitalinvested
(thusloweringreturnoncapital)butnotsmartgoodwill,since
itisunfairtoexpectcompaniestogenerateoperatingincome
on investments that they have not yet taken.
INTANGIBLE ASSETS WITH POTENTIAL FUTURE
CASH FLOWS