Investing Feeds

Following on from the article on ‘Valuing a company from Public Records’, presents me with the perfect opportunity to introduce the concept of ‘Goodwill’. Goodwill is the amount of value the market places onto a company that represents the intangible worth of that company. To illustrate let us consider the following data:

A Plc provides the following Data

It has a market capitalization of $1,000,000 ordinary $1 dollar shares which currently trade at $4 per share.

The Market is paying $4 for $1 Dollar share in the company, why? Because the market believes that based on the trading results and financial performance of previous years that $4 is a good price for the level of return that the company can provide (see the articles on PE Ratios and NPV to flesh out this explanation.) most of the shares traded will have Goodwill, in that the price will exceed the Nominal Value of the share, the surplus, called the premium, represents the Goodwill of the company.

Goodwill exists because a company provides a return on investment (most of the time) and the price reflects a number of things, the risk (or lack of) the investment, the level of the return in both terms of dividend and increase in value. The better these aspects of a company’s performance, the higher the share price (this is related to the laws of supply and demand)

The reverse holds as well, there is such a thing as Badwill. In the example given in ‘Valuing a company from Public Records’ where the share price was below the value of net assets divided by share issue, there was a deficit, the company was worth less in the market than it was on the balance sheet. Badwill arises when the market feels that the company is worth less ‘dead than alive’, but be wary of the true meaning of this judgment, as a companies’ stock can be ‘neglected’ by the market even though it may be a financially sound investment in terms of NPV. Goodwill is a complex subject and as always care should be taken where investment decisions are made in light of theoretical concepts. As will be seen in the next article on the ‘Theory of the Perfect Market’, what holds true in mathematics, does not always hold true in the real world.