Devoted to Managers and those that seek to improve their management skills

How Buffett Views Goodwill

One of the secrets that Buffett uses when evaluating businesses is the way he looks at goodwill. Most people look at goodwill of a business differently than Buffett.

With companies that produce products, they obviously require resources to produce; we call them assets. If you want to grow the unit volume of production, there's a very good chance that you'll have to increase your investment in assets.

With Buffett, he looks for companies that can increase their production without much increase in capital expenditures. Those are the types of businesses he considers having a great amount of goodwill.

There are a couple of major reasons for this. The first is that it is one of the things that many of his competitors haven't looked at in this way, and so offers him the unique opportunities he's had in investing without others knowing why - even after he's done it.

But secondly, and more important for management, is that it's a tremendous protection against an inflationary environment.

Buffett has said concerning the GAAP practice of amortizing goodwill against earnings is plain wrong, “In evaluating the wisdom of business acquisitions, amortization charges should be ignored...” When considering assets, which flies against conventional wisdom, Buffett believes that less really is more in reference to the amount of assets needed to produce revenue streams you are buying.

The one thing that trouble critics is that the result is that the value of the company if it's liquidated will be much less. That's not a problem for Buffett because he generally buys without the thought of ever selling a company. Of course he has, but he won't make decisions based upon an occasional anomaly to his strategy.

A great example is the growing earnings that Sees Candy has had over decades, which went like this: They earned $2 million on assets of $8 million in 1972, $27 million on $11 million in 1982, $50 million on $5 million in 1995. That's extraordinary no matter how you measure it.

The bottom line in economic goodwill is that the less it costs to increase production, the more inflation-proof a business is. And inflation is probably the greatest eater of businesses and capital that we face.

Other Buffett Resources:

Wisdom of Warren Buffett

Warren Buffett, investor

Warren Buffett: The trouble with being a legend

Warren Buffett: 'I told you so'

Company growth

Remember to Sign up for my feed, bizzbite and digg this!