Checking the Quality of Ocz Technology's Growth

Ocz Technology Group (Nasdaq: OCZ  ) carries $48.6 million of goodwill and other intangibles on its balance sheet. Sometimes goodwill, especially when it's excessive, can foreshadow problems down the road. Could this be the case with Ocz Technology Group?

Before we answer that, let's look at what could go wrong.

AOL blows up
In early 2002, AOL Time Warner was trading for $66.27 per share. It had $209 billion of assets on its balance sheet, and $128 billion of that was in the form of goodwill and other intangible assets. Goodwill is simply the difference between the price paid for a company during an acquisition and the net assets of the acquired company. The $128 billion of goodwill in this case was created when AOL and Time Warner merged in 2000.

The problem with inflating your net assets with goodwill is that it can -- being intangible, after all -- go away if the acquisition or merger doesn't create the amount of value that was expected. That's what happened in AOL Time Warner's case. It had to write off most of the goodwill over the next few months, and one year later that line item had shrunk to $37 billion. Investors punished the stock along the way, sending it down to $27.04 -- or nearly a 60% loss.

In his fine book It's Earnings That Count, Hewitt Heiserman explains the AOL situation and how two simple metrics can help minimize your risk of owning a company that may blow up like this. Let's see how Ocz Technology Group holds up using his two metrics.

Intangible assets ratio
This ratio shows us the percentage of total assets made up by goodwill and other intangibles. Heiserman says he views anything over 20% as worrisome, "because management might be overpaying for the acquisition or acquisitions that gave rise to the goodwill."

Ocz Technology Group has an intangible assets ratio of 23%. This is not so far over Heiserman's threshold as to cause panic, but you'll want to keep an eye on this number over the next few quarters. It's also useful to compare it with tangible book value.

Tangible book value
Tangible book value is simply what remains after subtracting goodwill and other intangibles from shareholders' equity (also known as book value). If this is not a positive value, Heiserman advises you to run away because such companies may "lack the balance sheet muscle to protect themselves in a recession or from better-financed competitors."

Ocz Technology Group's tangible book value is $87.4 million, so no yellow flags here.

By the way, I asked Heiserman about the tendency for some large-cap blue chips -- names like Procter & Gamble, IBM, and Altria -- to have a high intangible assets ratio and negative tangible book value. He says this can be OK, provided the company has (1) modest or no net debt, (2) persistent and rising levels of free cash flow, and (3) stock buybacks at a discount to intrinsic value.

Foolish bottom line
To recap, here are Ocz Technology Group's numbers, as well as a bonus look at a few other companies in its industry.

Company

Intangible Assets Ratio

Tangible Book Value (Millions)

Ocz Technology Group 23% $87
Intel (Nasdaq: INTC  ) 22% $30,534
STEC (Nasdaq: STEC  ) 2% $312
Seagate Technology (Nasdaq: STX  ) 0% $2,425

Data provided by S&P Capital IQ.

If you own Ocz Technology Group, or any other company that fails one of these checks, make sure you understand the business model and management's objectives. You can never base an entire investment thesis on one or two metrics, but there is a yellow flag here. I'll help you keep a close eye on these ratios over the next few quarters by updating them soon after each earnings report.

Fool analyst Rex Moore owns shares of Procter & Gamble but of no other companies mentioned in this article. The Motley Fool owns shares of Altria Group, Intel, and IBM and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Procter & Gamble and Intel and creating a bull call spread position in Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 19, 2011, at 1:01 PM, mwhummel wrote:

    OCZ hardly overpaid for the Indilinx purchase. Most experts in the industry are saying this was a great deal on a controller company for a measly $32 million dollars. Compare that to the recent SandForce purchase by LSI at a cost of $322 million. Might want to take more in depth view of this investment by OCZ. I think you are off your mark personally. The value OCZ gained by having their own controller company will pay extreme dividends back to OCZ for the future. They are no longer contingent on a 3rd party, they are required to buy less 3rd party controllers thereby increasing revenue, they also have an ability to offer innovative on chip solutions as is clearly evident in the latest controller offering featured in the Octane series. Sorry, strongly disagree that there is anything of concern here.

  • Report this Comment On November 20, 2011, at 3:13 PM, TRUTHisRARE wrote:

    What a joke OCZ will be bankrupt this time next year. If it weren't for borrowing and stock sales this company wouldn't have the cash to survive. Do NOT make a profit.

  • Report this Comment On November 20, 2011, at 8:01 PM, TMFOrangeblood wrote:

    Indeed, mwhummel, it's something to understand and keep an eye on. If you're comfortable with the purchase price and the level of goodwill, you should have no worries.

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