Home Business Goodwill Write-Downs Can Boost Stock Prices If Handled Well

Goodwill Write-Downs Can Boost Stock Prices If Handled Well

Goodwill impairments are never good news. They are admissions by management that investments haven’t panned out and projects have gone awry, but that doesn’t mean the market punishes companies for announcing a write-down. Most of the time investors have known that something is wrong, or at least worrisome, and priced that into the stock and owning the problem along with a clear plan forward can boost stock prices as much as a botched announcement can hurt it.

“Our research finds that investors often perceive such moves to be good news—as long as they already knew or suspected that an acquisition was underperforming,” write Bing Cao, Marc Goedhart, and Tim Koller for McKinsey & Co. “They applaud management for admitting as much and taking actions to improve the performance of the company.”

Sophisticated investors don’t take goodwill estimates at face value

As an intangible asset, goodwill is notoriously easy to abuse, but that doesn’t mean it has no basis in reality. Apple Inc. (NASDAQ:AAPL) really does have strong brand identity and devoted core customers, for example, and those traits have value even if they can’t be calculated concretely.

“Businesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return. The capitalized value of this excess return is economic Goodwill,” Warren Buffett wrote in his 1983 letter to Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) shareholders.

Sophisticated investors understand that goodwill is necessarily a matter of opinion and that reasonable people can sincerely arrive at different estimates, so they don’t just take corporate estimates on faith. When consensus estimates fall well below the official numbers, the stock price will usually reflect the former and the discrepancy could be a red flag for investors trying to gauge management’s ability to turn things around.

Boston Scientific jumped 10% after writing down $2.7 billion

That’s why companies that announce write-downs alongside revisions to forward earnings, cost-cutting measures, and well thought out management action plans are rewarded. As long as it isn’t a surprise, the write-down itself isn’t the news; management’s reaction is.

Cao, Goedhart, and Koller mention Boston Scientific Corporation (NYSE:BSX) as a particularly good example. Last year it wrote down $2.7 billion in goodwill related to the 2006 acquisition of Guidant and its stock price went up 10% because the company explained how it was already bringing its cost structure in line with its earnings and using free cash flow to service existing debt.