Goodwill impairments have stabilized since their 2008 surge, but still remain an important consideration in investment analysis. The Financial Executives Research Foundation (FERF), in conjunction with Duff & Phelps, provides a comparative analysis of the goodwill impairments of over 5,000 companies in their 2012 Goodwill Impairment Study. The study examines the intensity of goodwill impairments by industry and over time.
The study found that goodwill impairments continued in the $26 to $30 billion range in 2009 through 2011, down substantially from the 2008 peak of $188 billion. Bank of America, AT&T and Dean Foods had the highest amount of goodwill impairment in 2011. While financials continued to have the largest dollar amount of goodwill impairment in 2011, as they have since 2008, the telecommunications services industry led on a percentage basis.
Ratios Employed in Analysis
The study seeks to address three industry specific issues about goodwill impairment with three different metrics. First, the goodwill intensity ratio asks which industries have proportionately the most goodwill on their balance sheets. The ratio is calculated by dividing the amount of goodwill by the total assets measured at the end of each year from 2007 through 2010.
Next, the question of which industries' goodwill got hit the hardest is answered by using the goodwill loss intensity ratio. This ratio shows the goodwill impairment loss in a year as a percentage of the total goodwill in the prior year. This will show the rate of impairment for each industry's total goodwill reported.
Finally, the impact of goodwill loss on the balance sheet is examined with an asset loss intensity ratio. Here the study uses the goodwill impairment loss in a year as a percentage of the total assets in the prior year. This measure seeks to identify the impact of impairments on each industry's total assets.
These ratios form a tautology, of course, because the goodwill impairment to total asset ratio is the product of the total goodwill to total assets times goodwill impairments to total goodwill ratio:
Goodwill Impairments/Total Assets =
Total Goodwill/Total Assets x Goodwill Impairments/Total Goodwill
Goodwill to Total Assets
The total goodwill to total assets averaged 12%-13% each year from 2007 to 2011 across all industries. There was, however, marked variation between different industries.
The amount of goodwill exposure measured by this goodwill intensity ratio for different industries is intuitive. Because goodwill is recorded in a business combination, goodwill intensity is the greatest in industry sectors with significant mergers and acquisition activity in recent years. On an industry-by-industry basis, goodwill as a percent of total assets ranged from a high of 22% in the healthcare industry to a low of 2% for financials. Consumer staples and telecom services are on the high end of the scale while utilities and energy ranked on the low end.
Goodwill Impaired to Goodwill Reported
While the data showed that the average amount of goodwill as a percent of total assets varied little during the study period, the rate at which this goodwill was impaired was far from constant. In fact, the average amount of impaired goodwill to total goodwill has been about 1% in the recent 2009 to 2011 period, but the Great Recession years of 2007 and 2008 had rates up to ten times that amount.
In 2007 the rate of loss was a stunning 46% for the telecommunication services industry and 36% for the energy industry in 2008. Financials had an uneventful 0.3% ratio in 2007 which was propelled to 8% in 2008 in the recession. Financials have had their impairment rates fall substantially since then, but they had still had not returned to their staid 2007 rates by 2011.
Goodwill Impaired as a Percent of Total Assets
Using these two ratios we can get the total goodwill impairments to total assets. The survey found that the average goodwill impairment effects were far greater in 2008 than in 2011, 1.1% of assets versus 0.2% of assets.
Again, there are significant disparities by industry. The highest goodwill impairment to total asset ratios in 2011 were in consumer staples. And telecommunications services stand out as the highest ranking sectors followed by health care and information technology. Showing that it helps to have a big balance sheet in computing ratios to total assets, financials and utilities had the lowest goodwill impairment to total asset ratios.
Returns Calculated for Portfolios
In addition to an extensive set of balance sheet information by industry, the study provides a returns-based analysis. Overall, 7% of the S&P 500 reported goodwill impairment in 2011. This had been as high as almost 15% in 2008 and a low of about 5% in 2007. Not surprisingly, the stock of companies with goodwill impairments underperformed the S&P and those companies without goodwill impairments. The amount of underperformance is indeed large.
In order to understand the market impact information about goodwill impairment, the study examines the relative performance of each company's stock before and after the goodwill was impaired. The analysis was done relative to the announcement of the event to the market. For all the companies which announced goodwill impairment in the period from January 2005 through December 2009 stock monthly market returns were collected. The return on the S&P 500 Index (the market portfolio) was also computed.
In all there were 1,259 impairment events in the study. The return analysis first was conducted by breaking the stocks into three market-capitalization-portfolios: the Index portfolio and those with and without goodwill impairment announcements:
- Goodwill versus No Goodwill Impairment
- Losses to Total Assets -- High versus Low
- Losses to Total Goodwill -- High versus Low
The analysis was then repeated with the Index portfolio, and high loss and low loss portfolios. High and low loss portfolios represented companies which were the created from those firms which had goodwill losses to total assets ratios above and below the median values for the entire sample. High and low loss portfolios were also created for companies which had goodwill impairments to total goodwill above and below the median for the sample.
An intervention analysis, in which the month that the impairment was revealed was used as the intervention month, was conducted. This analysis was repeated for each set of portfolios. The results of these analyses were consistent with one another other. The coming impairment announcement by a company was hardly a secret to the market. Averaging these results shows that stocks which would experience an impairment announcement were underperforming the market by almost 5% in the period from six to twelve months before the announcement. Interestingly, the size of the underperformance decreased after the announcement. This would be consistent with the market overreacting to news of a possible announcement.Bill Sinnett is senior director, research with the Financial Executives Research Foundation (FERF), the research affiliate of Financial Executives International (FEI). He was previously employed by Carnegie-Mellon University and Mellon Bank in Pittsburgh. He can be reached at email@example.com.