Most companies aren’t worth as much as their assets are valued at. As seemingly unusual and inadequate this may sound, truth is, that every entity’s retail price is a lot higher, then the value of it’s entity’s, because it’s a brand with customers, prestige, intellectual capitol etc. In accounting this difference is booked as goodwill.
A stock price is a derivative of many components:
– number of public stocks
– estimated value
– potential in the future
– investors’ mood etc.
It’s extremely hard to define the accurate price of a share, this being amongst the reasons markets’ are so volatile. However in terms of accounting a company can be summed up as it’s net assets (mostly equipment, these are the easiest to liquidate if needed); it’s debt or liabilities and it’s goodwill.
As an example, imagine a company which is very well-known on a global scale, and take a look at it’s balance sheet, i.e. a company which handles international shipments. It may have a net worth of 25 million dollars, out of which 15 million is the value of equipment it owns and parallel to that it has no debts. If the company is purchased, then the remaining 10 million will be booked as goodwill. This greatly increases the value of it, that’s why many blue chips are worth astronomical figures; they have built a large reputation, attract millions of customers, such companies are Coca-Cola, BMW, Audi, Bank of America and so on.
The role of goodwill differs within private and public companies, because it can’t be valued in the first case. However after a business decides to go public it will be constantly be a subject to market valuation, this impacting the stock prices.
Goodwill is a very important thing to consider when investing your money, because in it’s the reason companies can attract more customers, therefore raising revenue, which will eventually lead to a rise of stock prices and mean earnings for you. Even though advertising and the production of high quality products, both contribute to goodwill, they can not be booked as an expenditure. This results in a paradox, because goodwill from acquisitions can be booked, however on contrary internal spending of such can not.
In certain circumstances goodwill can be negative, if for example the company has lost it’s customers due to bad production, a serious mistake has been made, bad management etc. In cases of such the value of it’s assets can overstep it’s acquisition price. These actions will surely have negative impact on stock prices, however if you have held on to shares during this tailspin, it is usually a good idea to wait until another individual or company buys the business’s assets and restarts production, restores previous states or assimilates it. If this scenario takes action, then stock prices usually rise.
Goodwill is very important when judging a companies potential and deciding if you should invest or not. Obviously the larger the better, but it isn’t a bad idea to check a balance sheet and make sure it also has assets, therefore can’t end in a bubble effect.