There are many ways a company can grow. It can do so organically, by expanding its products and services and hence its sales, or it can do so externally, by making acquisitions. There's a lot to be said for both methods, and companies many times try to do both.
The growth-by-acquisition strategy, though, is fraught with danger. A company can make an acquisition that doesn't fit; think AT&T
Zeke Ashton gave a stark illustration a few years ago of how a good company can ruin itself by failing to heed Lynch's warning. A company I own is a current illustration of the growth-by-acquisition philosophy. Sporting goods manufacturer K2 Inc.
By acquiring these companies, Heckmann has collected an assortment of sporting goods brands that are well-known, established, and respected: snowboard maker RIDE, baseball equipment company Rawlings, outdoor apparel maker Ex Officio, and more. Over the last two years, he's gathered under the K2 banner more than a dozen companies. Yet he's also added to K2's debt load, up 25% last quarter from the previous year, while doling out millions upon millions of new shares. The company currently walks a fine line; it still has some $18 million in cash in the bank, and it has taken a breather from its spending spree that has allowed insiders to buy up shares on a recent price dip.
To tell whether your company is a serial acquirer, you could read through the financial statements as companies spell out recent acquisitions they've made. But an easier way is to simply look at the balance sheet for a line item labeled "goodwill" or "intangibles."
When a company buys another, it pays for all the acquired company's machinery, plants, and other various hard assets. But it also pays for things that are hard to put a price on, such as brand recognition. If Home Depot
I use a Goodwill to Assets ratio (G/A) to determine whether a company is a serial acquirer. To calculate the ratio, I go to Microsoft's
K2 has intangibles in the last quarter totaling $271.8 million and total assets of $887.6 million for a G/A ratio of 30.6%. Anything greater than 10% and the company is at least partly financing its growth through acquisitions. Not everything included in intangibles will be an acquisition, but there is enough of a precedent to make the analysis worthwhile.
Here is a list of companies that grow organically and a list of those growing through acquisitions:
| Organic Growers | Growth by Acquisition | ||
|---|---|---|---|
| Home Depot | 3.5% | Krispy Kreme | 26.6% |
| Lowe's | 0.0% | PeopleSoft | 32.9% |
| Harley-Davidson | 2.8% | Cisco | 12.7% |
| Oracle | 0.0% | eBay | 30.9% |
| Wal-Mart | 9.2% | Proctor & Gamble | 41.9% |
Also be leery of a company that makes an acquisition that is quite large in terms of sales or market cap. If the acquisition, or a series of acquisitions, is at least 25% as large as the acquiring company's original size, take a hard look at your investment. Swallowing a company that large can only give you indigestion.
There can be good reasons to acquire a competitor. K2, I think, has thus far made a compelling case for the acquisitions it has made. Still, I'm keeping a close eye on the situation. Too often serial acquirers go awry and turn into serial murderers of investments. Use this simple test to keep them at bay from your portfolio.
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Fool contributor Rich Duprey is a serial drinker of Coors Light. He owns shares of K2 but does not own any of the other stocks mentioned in this article.
