The Business of Value Investing.pdf

238 The Business of Value Investing

Goodwill is an intangible asset, and valuing intangible assets

can be tricky, because their values differ from one company to the

other. For example, the brand values of Coca - Cola and McDonald ’ s

are vital to the long - term success of those businesses. Coke is what it

is because of the worldwide familiarity with its name, and reference

to the “ golden arches ” is all about McDonald ’ s.

Goodwill, however, is different from other intangible assets.

While it is very unlikely that brands like Coke would ever lose

value, goodwill can go away, and companies must respond by

writing off its value in their fi nancial statements. If a businesses

acquisition doesn ’ t work out, then it may write off the goodwill

associated with that acquisition. Goodwill is certainly not the only

asset that can be written off; inventory, receivables, and even short -

term noncash investments can be written off. But while businesses

usually can recover at least some value from physical assets, good-

will can end up being worthless to a prospective buyer — because

it only represents how the previous buyer valued the assets of the

business.

Thus, investors need to proceed with an added degree of cau-

tion and skepticism when examining any business with substantial

sums of goodwill on the balance sheet. When the markets are sour,

as they were in 2008 and heading into 2009, the value of goodwill

should be discounted by at least 50 percent when examining the

book value of a company.

Consider the situation concerning Mueller Water Products, Inc.

At the end of 2007, the company ’ s balance sheet showed an unusu-

ally high amount of goodwill.

Mueller Water ’ s goodwill alone represented over 60 percent of

shareholders ’ equity. Along with intangibles, these two categories

exceed shareholders ’ equity by 20 percent. Mueller had been spun

off by Walter Industries in 2004. As part of the spin - off; Mueller

took on the existing goodwill of Walter ’ s businesses that were being

transferred to Mueller.

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