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Is Exelixis' Growth for Real?

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Exelixis (Nasdaq: EXEL  ) carries $63.7 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 Exelixis?

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 Exelixis 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."

Exelixis has an intangible assets ratio of 16%.

This is below Heiserman's threshold, and a sign that most 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."

Exelixis' tangible book value is -$60.6 million, which obviously raises a yellow flag.

Foolish bottom line
If you own Exelixis, 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 no companies mentioned in this article. The Motley Fool owns shares of Exelixis. Motley Fool newsletter services have recommended buying shares of Exelixis. 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 (3) | Recommend This Article (4)

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 04, 2012, at 4:43 PM, Ruhaan wrote:

    This article is joke really... Its not a comment on Rex's knowledge as I am sure he is only doing so because Fool requires a certain number of articles. But really you guys are loosing focus. The goal should be to try and write some insightful articles that brought me to this sight originally instead of churning out crap run of the mill articles. I may click on these articles and that may generate ad revenue for you but in the end, you will actually drive people away. I am getting smarter and I believe so are other people about these so called stupid, dumb articles. Therefore there are hardly any recs these days. Down the road your advertisers will catch on too but you may do some irreparable damage to your brand.

    - Ruhaan

    advice on how not to run your business.. please take it seriously

  • Report this Comment On January 04, 2012, at 9:26 PM, hiddenflem wrote:

    Agree with Ruhaan. EXEL's share price will rise or collapse based on one drug. Trying to evaluate the company using your metrics seems like an exercise in futility to me. Aren't the risks in investing developmental stage biotechs obvious? Do we really care about 'organic growth' at this stage when we know that the EXEL lives or dies by the results of their CABO trials and partnerships?

  • Report this Comment On January 10, 2012, at 2:05 AM, TheAbidingDude wrote:

    I also agree with Ruhaan & hidden. Total waste of time applying these kinds of metrics to a biotech like EXEL.

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5/27/2016 4:00 PM
EXEL $6.34 Up +0.04 +0.63%
Exelixis CAPS Rating: ****