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Why you must pay attention to goodwill on a company's balance sheet

by , 29 July 2015

When looking into companies to invest in, it's easy to concern yourself with profits. And this can lead you to ignore the balance sheet.

But you need to pay attention to the balance sheet, particularly goodwill.

Here's why…

What is goodwill?

The balance sheet contains a company’s assets. You’ll find goodwill listed here.

Goodwill is an intangible asset. It can be a number of things that a company attributes a certain amount of value to.

Examples of goodwill include the value of a company’s:

  • Brand;
  • Marketing team;
  • Business concept; and
  • Customer base.

Some investors don’t attribute value to the goodwill detailed in a company’s balance sheet. They don’t see it as an actual company asset. After all, can you really put a price of these intangible assets?

If you’re looking to invest in a company with a high value of goodwill in its balance sheet, you need to believe in the amount a company places on these intangible assets.

If it’s a unique business idea for instance, you may be willing to pay many multiples of book value to account for this.

But a company can write goodwill down and this can result in losses, Bengt Saelensminde in The Right Side explains.

What to check in a company’s balance sheet before investing

Check how many times book value the share price is trading at. This gives you an indication of how expensive the stock is.

Then turn to goodwill items.

If you’re not sure how much these items are really worth, be cautious. It can come down to pure speculation and this increases your investment risk.

If a company’s trading on a low price to book valuation, it’s a lower risk investment than buying into a stock where this valuation is high. Companies with low price to book valuations are more likely to be in the sights of larger companies as a takeover target.

So there you have it. Why you must pay attention to goodwill on a company’s balance sheet.

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Why you must pay attention to goodwill on a company's balance sheet
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