How to Spot Serial
Acquisition-fueled growth is like a
Ponzi scheme. It works until something goes
the market recovers, most investors will want to hop on growth stocks to
get in on the action.
look for stocks that have already racked up strong sales and earnings
growth, and are expected to continue their winning ways.
That makes sense since share prices usually track
earnings. But beware. Some firms resort to a "Ponzi like" acquisition
strategy to spur growth.
Such strategies usually
end badly. I'll describe how to spot those rascals in a minute, but
first some background.
Must Have Growth
In the beginning, most firms grow organically, that is, their
growth comes from selling more products, or by opening new stores. Alas,
eventually supply catches up with demand or new competition appears, and
But top executive’s wealth is usually tied
to the company’s stock price one way or another, and word of slowing
growth has a nasty way of driving a firm’s share price into the ground.
With that as an incentive, management tries to find new ways to keep the
Most firms develop new products or enter
additional markets, but others turn to an acquisition strategy to
maintain growth. I call such firms “serial acquirers,”
The Dark Side
Growth by acquisition is an appealing strategy. Purchasing an
established company saves the acquirer the time and expense of learning
the business and developing products from scratch. The process is
relatively inexpensive because the acquiring firm usually uses its own
shares to pay for the deal.
The acquisition strategy is often
successful early on, allowing the serial acquirer to maintain its strong
growth rate, keeping the market happy and its share price up. The latter
is important because the firm’s stock is the currency enabling the
Eventually, however, the numbers get too
big. Consider the math. A company
with $100 million in annual sales can achieve a 25% growth by acquiring
a company selling $25 million a year. However once it gets to the $200
million level, it must acquire firms with $50 million in annual sales to
maintain the same growth rate. Compounding the problem, the bigger it
gets, the fewer the number of acquisition candidates.
Something Goes Wrong
Sooner or later, something goes wrong. Perhaps the firm overpays
for an acquisition, or the expected cost cutting synergies fail to
materialize. Maybe a clash between corporate cultures drives key
employees in the acquired company out the door. Possibly, the acquired
firm’s products don’t sell as well as expected.
Whatever the cause, the serial acquirer
fails to meet earnings growth forecasts, torpedoing its stock price. The
lower stock price takes away its acquisition currency, further slowing
growth and thereby putting more pressure on its share price. It’s game
Easy To Spot
Spotting serial acquirers in easy. You’ll need to dust off your
calculator, but it’s a simple calculation. Here’re the details. .
When an acquisition happens, the acquirer
almost always pays more than the target firm’s accounting book value.
When it does, the acquirer adds the difference to either the goodwill or
intangibles lines on its balance sheet. In fact, acquisitions are the
only way that numbers get added to those categories. Both would be zero
if a company has never made any acquisitions.
Thus, you can gauge a firm’s acquisition
history from the value of goodwill and/or intangibles on its balance
sheet. But, even firms that aren’t using acquisitions to fuel growth
have probably made a few strategic buys over the years. So those numbers
don’t mean much by themselves. You have to compare them to something
that reflects company size. I’ve found that ‘total assets’ does the job.
It’s listed close to goodwill and intangibles, so you can do your
The process involves comparing the total of
goodwill plus intangibles to the total assets. I call the result the
“acquisitions ratio.” The higher the ratio, the more acquisitive the
Doing The Math
You can find the needed information on many financial sites. I’ll
describe the process using Yahoo Finance (finance.yahoo.com).
Using drug store chain Walgreens (WAG) as
an example. First get a
Balance Sheet in the Financials section. Finally, select
Data so that you’re using the most recent information. Yahoo lists
goodwill and intangibles (intangible assets) in the long-term assets
section, and total assets at the bottom of that section. Always use the
most recent information, which was the November 30, 2008 report for
Walgreens. Yahoo listed $1,400 million for goodwill, zero for
intangibles, and $24,513 million for total assets. Thus, the
acquisition ratio for Walgreens is 6% ($1,400
divided by $24,513).
Next, do the same thing for Walgreen’s
competitor, CVS Caremark (CVS).
Looking at the December 2008 figures, Yahoo listed $25,494 million for
goodwill, $10,446 million for intangibles, and $60,960 for total assets.
Doing the math, CVS Caremark’s acquisition ratio was 50%.
Both Walgreen’s and CVS Caremark are
relatively fast-growing firms. However, the numbers tell us that
Walgreen’s is mostly growing by opening more stores (organically) while
CVS Caremark is relying mostly on acquisitions to fuel growth.
Here are the acquisition ratios for a
sampling of familiar firms.
Abercrombie & Fitch, 0%
• Apple, 1%
• Bed Bath
& Beyond, 0%
• eBay, 50%
• J M
• Nike, 8%
• Proctor &
As a rule of thumb, organic
growers usually show ratios below 5%, and ratios of 15% or more identify
firms growing at least partly by acquisition.