goodwill in excess of market value of equity

Could anyone please comment on why goodwill in excess of a company’s market value is a potential clue for future write-offs? I am quoting from Reading 19 Evaluating quality of financial statements. There is an example but I am still not getting it.

Any goodwill is always in danger of impairment. So what?

It also says “If the market cap exactly equaled the reported amount of goodwill, the value implicitly assigned to all the company’s other assets would equal zero.” Isn’t that the case when the company is all equity funded?

If a firm were all equity funded I don’t think the value implicitly assigned to all its assets would be zero; because issuing equity gives you cash, and cash is an asset

Not entirely sure on your other question but …

Goodwill is just the premium paid above fair value of net assets. So good will is voodoo magic value, i.e. value added via “synergies” following an acquisition. And history says synergies rarely pay off

the Curriculum basically says that if the goodwill on balance sheet is larger than the market value of equity, the write-off is inevitable…

Probably because they will have to impair the goodwill if the ivestment’s market value is less than the carrying value?

Hey, goodwill! My old friend goodwill. It doesn’t have anything to do with how a company is financed. If the goodwill on the BS is greater than the market cap of the company, something unusual is going on.

Go back to what goodwill is. If you/company buys another company, then all of the target’s assets/liabilities (including intangibles like trademarks) are revalued to fair market value (fmv). If you pay more than the fmv of the target’s assets/liabilities then you have goodwill. It happens all the time.

Now fast-forward three years. What if this fmv figure of goodwill is greater than the market value of your whole company?!? How can this be? The implication is that the whole company, less this goodwill accounting entry, has negative value.


Extracurricular moment, likely outside of the scope of the CFA Exam: I think it is theoretically possible that Goodwill > MV of company and no write-down is necessary. Key point - there could be a case where one business unit (bu) is worth more than the whole company. For example, an organization has one bu that is super-profitable business and the rest of their businesses are worthless. That super-profitable business may have grown due to acquisitions that have carried signifcant goodwill. And goodwill is carried an impaired at the bu (“reporting unit” in US GAAP) level It is certainly possible. But going back to the first paragraph "something unusual is going on " if Goodwill > Market Cap.

Goodwill is reported as an asset on the balance sheet. If goodwill has the same value as equity then everything else has to be $0 in order to make the balance sheet balance, otheriwse things won’t balance. However, we know that those other assets/liabilities are worthmore than $0, so goodwill has to be written down to give value back to those assets/liabilities. I hope this helps.

If goodwill has the same value as equity AND the company has nonzero liabilities, then it has assets other than goodwill that are nonzero. BS will balance and no need to write anything off…

tso, the idea of writing down goodwill isn’t to balance the books. It it has to do with the economics of the situation.

As an investor, what would you think if the goodwill on a company’s BS was greater than the market cap of the company?

I’d think: This company almost definitely overpaid for its acquisition(s). And I’d wonder, if this goodwill figure is real, then why isn’t this company worth more? And this may be mor specific to me since I’ve been involved in goodwill impairment calculations, I’d wonder what their model looks like. The company’s internal model that supposedly supports the goodwill figure appears to be inconsistent with what the “market” is saying (the models I’ve seen are all DCF models). Is the market missing something? Or does indeed the goodwill need to be written down?

This. I’m just very bad at explaining things.

I think I got it. Thanks.

I know I am six years late, but let me philosophize.

1- Rule of thumb is Assets are equal to Liabilities and Equities. A = L + E
2- If Goodwill, part of Assets is equal to Equities, then the remainder of assets and liabilities match the same, A + G = L + E this is acceptable but also is the breakeven point where assets and liabilities will cancel each other out "A + L = 0 ".
3- As goodwill grows bigger than Equity, Assets will drop lower than liabilities, A+L=(negative $$$).
4- Hence, goodwill is impaired to rebalance to breakeven point A + L = 0.