We always see the term "GOODWILL" appears in companies' balance sheet. So, what is a goodwill? According to oxforddictionaries.com, goodwill is "the established reputation of a business regarded as a quantifiable asset and calculated as part of its value when it is sold". Sound hard to understand? Well, in a layman term, it means a company is sold to a buyer company at a higher price than its NAV. The difference between the higher buying price and the lower NAV will be shown in buyer company's balance sheet as goodwill.Now, you may ask, why does a buyer company want to spend more to buy a company that worth less? Well, we should look at this kind of buying from the other angle. Say the seller company has been doing good for years and its earning and return to shareholding are growing without fail. In this sense, seller company will consider its business future growth potential as a strong selling point when negotiating with buyer company. In turn, the buyer company will evaluate the seller company's potential at the same time. If the earning future of the seller company is there, the buyer company do willing to spend more to acquire it.
Some argue that goodwill does not carry any value in actual as it will be amortized from time to time, just like a depreciation. Well, as of my opinion, it is true only if it is a positive acquisition that generates goodies for both buyer and acquired companies as the value will return to shareholders in future. With this sense in mind, we may consider to remove goodwill from Assets. This exercise will reduce shareholder equity in turn. Therefore, the Return on Equity (ROE) will become better.
Therefore, do try hard to study the content of goodwill as well before your investment. Do note that higher goodwill with over expansion will not create value to shareholder.
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