Eagle Rock Soars With These 2 Metrics

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Eagle Rock Energy Partners (Nasdaq: EROC  ) carries $111.3 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 Eagle Rock?

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 Eagle Rock 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."

Eagle Rock has an intangible assets ratio of 6%.

This is well below Heiserman's threshold, and a sign that any growth you see with the company is probably organic. But we're not through; let's also take a look at 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 avoid the company because it may "lack the balance sheet muscle to protect [itself] in a recession or from better-financed competitors."

Eagle Rock's tangible book value is $935.2 million, so no yellow flags here.

Foolish bottom line
To recap, here are Eagle Rock's numbers, as well as a bonus look at a few other companies in its industry:


Intangible Assets Ratio

Tangible Book Value (millions)

Eagle Rock Energy Partners 6% $935
DCP Midstream Partners LP 14% $388
Enterprise Products Partners LP 11% $7,660

Data provided by S&P Capital IQ.

Eagle Rock appears to be in good shape in terms of the intangible assets ratio and tangible book value. You can never base an entire investment thesis on one or two metrics, but there are no yellow flags here. If any companies you're researching do fail one of these checks, make sure you understand the business model and management's objectives. 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 no companies mentioned in this article.

Motley Fool newsletter services have recommended buying shares of Enterprise Products Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

Read/Post Comments (1) | Recommend This Article (1)

Comments from our Foolish Readers

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 January 03, 2012, at 1:56 PM, zorro6204 wrote:

    That's a completely ridiculous analysis. Of all the metrics one could use to analyze an MLP, intangibles and tangible book value has to rank near the bottom of the stack. Why? For the thousandth time, the balance sheet is presented under GAAP rules at historical cost, less depletion and depreciation. And for the umpteenth time, here's an example of how useless those numbers are:

    Company A owns reserves it bought many years ago, at a depleted historical cost of $500M. But the reserves are now worth a billion due to increased oil prices. Company B buys the reserves from company A for a billion. Because that is the historical cost for Company B, those assets are now carried at twice the GAAP value as they did the previous day on the books of Company A. Same exact assets, two wildly different carrying costs. Obviously analyzing Company A and Company B based on tangible book value would be a fool's errand (humor, ark ark).

    Furthermore, intangibles can also be tremendously misleading when they arise due to hard assets. For example, suppose Company B had bought all the units of Company A and merged the two companies together. Under GAAP rules it would be required to continue carrying the reserves of Company A at $500M. The extra $500M it paid for the equity in those reserves would have to be booked as goodwill. Again, the balance sheet looks dramatically different just based on the manner in which the assets found their way to the balance sheet.

    Regarding the real metrics which should be used to value EROC - DCF, reserve composition and life, the age and location of its midstream assets, net debt to cash flow and so forth - EROC doesn't exactly shine. It's still burdened with debts when it over extended itself leading up to the financial crisis of 08-09, and hasn't recovered yet. It hasn't even conducted an offering to expand, when its peers have done multiple raises. It's years away from getting back to being reasonably levered, there are better midstream and upstream choices out there.

    Disclosure: Quite long due to how incredibly cheap it got during the restructuring, but wish I had that capital deployed elsewhere, like VNR, MWE, etc.

Add your comment.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1751346, ~/Articles/ArticleHandler.aspx, 10/21/2016 6:02:38 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 18,145.71 -16.64 -0.09%
S&P 500 2,141.16 -0.18 -0.01%
NASD 5,257.40 15.57 0.30%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

12/31/1969 7:00 PM
EROC.DL $0.00 Down +0.00 +0.00%
Eagle Rock Energy… CAPS Rating: ***