Economic goodwill

Economic goodwill is different from accounting goodwill. The latter is a subject in the balance sheet of an enterprise and a part of the book value of assets. However, economic goodwill is a deeper but difficult-to-define item, which has an important impact on the intrinsic value of enterprises.

The primary economic feature of economic goodwill is that the actual value of assets of enterprises whose return on net assets exceeds the average level is greater than the book value. For example, Bill Company, a blue-chip company, offered $25 million when 1972 acquired Xishi Candy Company. At that time, the book value of Xi Shi Candy Company's assets was $8 million, and there was no debt. The annual after-tax profit is $2 million, and the return on equity is 25%. Buffett believes that this kind of high income is not brought by the assets such as factory buildings and equipment on the books of Xi Shi Candy Company, but created by Xi Shi Candy Company's reputation as an excellent candy supplier. Because of its good reputation, Xishi Candy Company can set a price far higher than the product cost, which is the essence of economic goodwill. As long as we continue to maintain this good reputation, we will continue to generate high returns; The economic goodwill will remain stable and may even increase. (Note: Before the acquisition of Xishi Candy Company, Buffett basically followed the investment strategy of his mentor Graham and adopted the "cigar butt" investment method. With the strong encouragement of partner Munger, Buffett finally bought Xishi Candy Company at a price more than three times the book value, from which he tasted the sweetness, thus promoting a major change in his investment philosophy and investment concept. I will tell this case in other posts when I have the opportunity in the future. )

According to previously accepted accounting standards, accounting goodwill must be amortized within a certain period of time. Therefore, accounting goodwill will not increase, but will decrease. When an enterprise is acquired at a price higher than the book value, the part exceeding the book value becomes goodwill and is distributed to the asset side of the balance sheet. Like other assets, this part of goodwill will be amortized for 50 years, and the goodwill will be reduced by 1/50 every year to offset the income of the current year. As the Blue Chip Bills Company acquired Xishi Candy Company at a premium of170,000 USD, a goodwill account was set up on the asset side of the balance sheet of the Blue Chip Bills Company. Amortize 1/50 of the goodwill from the balance sheet every year, that is, $425,000, to offset the income of the current year. After several years, the accounting goodwill has decreased, but as long as the good reputation of Xi Shi Candy Company persists, its economic goodwill will continue to increase.

The existence of economic goodwill not only makes the return on net assets exceed the average level, but also the value of economic goodwill itself often rises with the rise of inflation. Understanding the economic characteristics of economic goodwill is the basis of understanding Buffett's investment philosophy and investment philosophy. To illustrate the truth, Buffett compared Xishi Candy Company with an imaginary company B. Xi Shi Candy Company has a net book value of $8 million and an annual profit of $2 million. Assuming that company B can also make a profit of $2 million a year, it needs assets of $654.38+$8,000. Assuming that Company B has no debt, its ROE is 1 1%, which is the average level of the same industry in the United States. Therefore, the economic goodwill of Company B may be little orno. Company B sells at the market price of $6,543,800+0,800, which is the book value of its assets. However, when buying companies with higher-than-average return on net assets, they often have to pay a price higher than their book net asset value. Buffett's blue chip Bill Company paid $25 million for Xishi Candy Company, which was $7 million higher than the book value of Company B.. Although the annual income of the two companies is the same, the book value of Xi Shi Candy Company is less than half that of Company B ... Buffett, let's think about it. Is the market value of Xishi Candy Company with a small book value greater than that of Company B? The answer is yes. Buffett pointed out that as long as you believe that we live in an inflationary world, the answer is yes.

In order to evaluate the impact of inflation on these two companies, it is assumed that if inflation increases the book value of assets by 65,438+0 times, both companies can increase their after-tax income to $4 million through price multiplication to keep the return on net assets unchanged. The key difference between Xishi Candy Company and Company B lies in the influence of inflation on asset value. Inflation can make the two companies raise prices, but it also needs to increase capital expenditure. Buffett pointed out that if the sales volume increases by 1 times, more investment is needed in inventory to support this sales level. Although fixed assets may react slower to inflation than inventory, factories and equipment will eventually be replaced by factories and equipment with higher costs.

Since Xishi Candy Company made a profit of $2 million with only $8 million in assets, in order to make the profit reach $4 million, it only needs to add $8 million in assets. However, Company B needs to increase its assets by $6.5438+$0.8 million to earn another $2 million. Company B has put into production assets of $36 million, with a profit of $4 million and a return on net assets of 1 1%. The price of company B should be close to $36 million. At this time, for every 1 USD invested by the shareholders of Company B, the market value of 1 USD was created. Xi Shi Candy Company earned a profit of $4 million with assets of $6.5438+0.6 million, and its market value should be $50 million. Buffett pointed out that Xi Shi Candy Company created a market value of $25 million with only an investment of $8 million, in other words, the market value earned per 1 dollar exceeded $3.

Enterprises with slow asset turnover can usually only get a lower return on net assets. These enterprises need to increase capital expenditure to maintain profitability. In the period of high inflation, it is almost impossible for these enterprises with huge assets to obtain enough cash to meet the needs of increasing capital expenditure, repurchasing stocks and greatly raising dividend levels. In essence, enterprises that need a lot of capital expenditure are cash consumers, not cash producers.

Buffett firmly believes that during the period of inflation, only a few enterprises can gather a lot of wealth, because these enterprises can combine their economic goodwill with the minimum capital expenditure demand. When the income increases, the management of these enterprises can increase dividends or buy back shares. Buffett believes that "in the period of inflation, economic goodwill is a constant gift." Because Buffett has suffered from bad companies, the stock god is very sensitive to those companies with low yields. It is the investment experience of Xishi Candy Company that makes the stock god deeply realize the value of economic goodwill. Buffett once said: "The investment experience we have learned from Xishi Candy Company enables us to make huge profits from other common stocks." .