Of all the items on a conventional accounting balance sheet, none gives me more trouble than goodwill. It is not an insignificant item for some companies, amounting to a large percentage of overall assets, but it does not show up on the balance sheets of other companies. To anyone who encounters it, there are five questions that follow: What is it? Why it is there? What does it measure? Can it change over time? What do we do with it?What is it?While goodwill connotes something substantial, it is a plug variable. Note that it shows up on a balance sheet only when a company does an acquisition....
Accounting inconsistencies
In the next few posts, I plan to focus on the accounting inconsistencies that bedevil analysts. In particular, here are the items that I will highlight:1. Goodwill: When a company acquires another, goodwill shows up on the balance sheet of the acquiring company. While the name connotes something of substantial value, goodwill as it is currently computed is really a plug variable, designed to make the balance sheet "balance". Goodwill skews book values of equity and capital and wreaks havoc on earnings.2. Minority interests: This is perhaps the most misleading item on a balance sheet, at least...
Government Default and Riskfree Rates
I have several posts on potential government default and riskfree rates. I noticed this story in Business Week. I know that this is only one observation but it is a troubling one. In emerging markets, it is not uncommon for companies to borrow money at rates lower than the government, but the saving grace is that the borrowings are in a foreign currency. I can see why bond holders saw less default risk in dollar bonds issued by Petrobras in 2004 than in dollar bonds issued by the Brazilian government.In this case, lenders are actually perceiving less default risk to Berkshire Hathaway than to...
How do you measure profitability?
I have assiduously stayed out of the health care debate that has dominated the news in the United States for the last year, since everyone involved in it seems to come out of it looking worse for the wear. However, there is one aspect of the debate which I have found fascinating, revolving around how profitable or unprofitable the health care business is for insurers, pharmaceutical firms and hospitals. Let me be clear up front, though. This is not a post about health care reform but about how best to measure profitability.On one side of the debate, you have proponents of health care reform arguing...
Equity Risk Premiums and the Fear of Catastrophe
As many of you already know, I am a little fixated on the equity risk premium. More than any variable, it explains what happens in equity markets both in the short term and the long term. In fact, I have at least a dozen posts over the last year and a half on the evolution of the equity risk premium in the US and globally.The equity risk premium measures what investors collectively demand as a premium over and above the riskfree rate to invest in equities as a class. In practice, many analysts use historical data to estimate this premium. Thus, if investors have earned 9% on stocks over the last...
