Investing 101: Balance Sheet – Goodwill & Total Assets
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
More losses in the stock market are caused by not knowing how to evaluate a company's fundamentals. When it comes to analyzing a company you need to know what is on their balance sheet. I'll walk you through some of the basics, and give you an example of how this relates to your finances to make things easier. Given that books have been written on how to read a balance sheet, I'll try to keep this simple. I've already covered cash & investments, as well as receivables & inventory in two other posts. Today let's look at Coca-Cola (NYSE: KO) to examine goodwill and total assets. In following posts I'll explain other parts of the balance sheet.
You can find the company's balance sheet on many finance web sites like Motley Fool, Yahoo Finance, Google Finance, etc. The balance sheet is usually broken into three parts, assets, liabilities, and stockholders equity. (Keep in mind when you see numbers on a balance sheet they are normally quoted “all numbers in thousands or millions”. This is how $10,300,000 or $10,300 can actually mean $10.3 billion, don't forget to add those 3 or 6 zeros!)
When it comes to goodwill, the simple explanation is this is an accounting line item and not real cash. When a company buys another, goodwill is the amount paid over and above the physical assets being purchased. Coca-Cola, in our example, shows about $12 billion in goodwill. This means in the past, when Coca-Cola purchased a company for say $2 million, they might have received $1.5 million in assets. The $500,000 difference between what they paid, and what they received, is recorded as goodwill. The company is required to write down (or decrease their earnings), over a certain amount of time, to eventually eliminate this goodwill from their balance sheet. The fact that Coca-Cola has over $12 billion in goodwill, shows how much they had to pay for certain companies brands. Since goodwill is continually being written off against earnings, it's a line item to pay attention to. Just as a point of reference, Coca-Cola reported in September 2011 that they produced net income of $2.756 billion. The company actually made $466 million more than that, but this $466 million was written off as depreciation. As an investor you want to know if a company has goodwill they are writing down, because their reported earnings will be less than they actually made. In addition, goodwill can sometimes be deceiving, as the company may or may not be worth as much as they paid for the acquired companies. That brings us to total assets.
Total assets is exactly what it sounds like, anything and everything a company has. This number represents in theory if a company liquidated everything it had and turned everything into cash. This would mean selling every piece of land, equipment, inventory, etc. The challenge with total assets is these are stated assets, and not necessarily real numbers. What I mean is, goodwill for instance, may or may not be worth what the company believes. If a company overpays for an acquisition, they may record $500 million as an asset, but if they tried to re-sell the same acquired company they might only get $250 million. In this way goodwill can overstate assets. This is also true of inventory. A company might say they have $200 million in inventory, but if they liquidated it all tomorrow it might only fetch $125 million. This can work in the opposite direction as well. Railroads are great examples, CSX (NYSE: CSX) might say they have $24 billion in plant and equipment. However, if CSX liquidated everything they have, land included it might go for two or three times that number. Long story short, take total assets with a grain of salt. Think of total assets like if you sold every single asset you have and piled the money up on a table. You know how much your cash in the bank is worth, but those jeans from 3 years ago you might not be able to give away.
If you are looking for companies that might be worth more than their total assets, I would look at companies that have a history of acquisitions. We've already seen that Coca-Cola is a good example. PepsiCo (NYSE: PEP) comes to mind as well. PepsiCo shows $16 billion of goodwill on their balance sheet versus about $75 billion in total assets. Dr. Pepper Snapple Group (NYSE: DPS) is a logical choice also. Dr. Pepper Snapple shows $2.9 billion in goodwill versus about $9.1 billion in assets. Remember, the larger the goodwill amount, the more the company is actually making behind the scenes versus their reported earnings.
This is the last of the 3 posts about the asset side of the balance sheet. I'll also be posting some details about the liabilities side of the balance sheet as well. In the meantime, let me know if you have any questions or comments in the section below.
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