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Strategies & Market Trends : Buffettology -- Ignore unavailable to you. Want to Upgrade?

To: cfimx who wrote (1584)	6/9/1999 3:19:00 PM
From: Michael Burry	Read Replies (2) \| Respond to of 4691

Ok, you've kind of made my point. When a purchase is made at a given point in time, that goodwill has had a value placed on it. If it turns out the purchase is smart, it will increase over time. If it's dumb, it will decrease over time. Did the company overpay or underpay, or pay exactly the PV of future returns? This is what determines whether and to what degree goodwill should be amortized, and this is what I mean by differentiating goodwill. In Buffett's case, with the companies he buys, he knows with certainty that he is underpaying for the sustainable competitive advantage that will be represented on his balance sheet as goodwill. It is likely that he uses more than ROE to determine this. It is therefore ridiculous to amortize for that company. But for all the rest of us, there has to be more thought into it. For instance, Barbie is fine (debatable but lets assume it's true). But is Matchbox fine? Reader Rabbit? Carmen Sandiego? Will they always be, and will they grow in value over time? What portion of Mattel's and TLC's acquisitions over the years have provided an economic return showing that they underpaid for growing goodwill? When a company is acquired, an investment is made. I'm simply not assuming Mattel and TLC have the investment prowess of Buffett. Then this gets to very key issue of whether we should be eliminating the goodwill to make our return calculations. Well, it depends. For a recent acquisition, by purchase accounting, hasn't the net worth on a per share basis already been reduced by the amount added by the acquisition - the equilibrating factor being goodwill? Should we give a company credit for acquiring a potentially worthless company by writing down their net assets (by subtracting assets/adding debt/issuing shares and not adding goodwill) from the pre-acquisition status and making return calculations? With a pooling of interests, there still should not be credit given for the pre-merger buying sprees of one or both of the companies. Which is why I use the pro forma numbers and present the analysis as I did. Again, it comes down to, when assessing companies with recent acquisitions, that if you are not going to amortize, then you should label the goodwill as an asset and leave it there. Over time, the returns on the company's investment will become apparent. And they should be calculated off the balance sheet with that asset in there. Otherwise you are double counting, and inflating returns on a balance sheet depleted by an acquisition. To address another issue, there is really no point in writing up Coke's or See's goodwill to appropriate current values unless for some reason I wanted to make an acquisition. Then I would want to know the present value of that goodwill in order to see if I was paying more or less for it. In sum, to add back amortization to your income statement then subtract the item being amortized from the balance sheet will give return numbers that inflate the actual performance characteristics. I'd rather add back amortization to the income statement and leave the asset on the balance sheet, limited by the percentage of goodwill that qualifies for such treatment. Mike