How to Avoid the Goodwill Asteroid

One of the gravest fears of investors today is being totaled by an "asteroid" event -- moments when a stock gets pushed to the edge of extinction by a bolt from the blue, such as a drug application rejection, a securities probe revelation or a surprise earnings restatement.

Yet many shareholders seem blithely unaware that at least one asteroid speeding toward their companies is entirely foreseeable: the likelihood that management will have to write down a decent-sized chunk of their net worth sometime this year and perhaps rather soon.

This unfortunate prospect is faced, potentially, by companies such as AOL Time Warner (AOL Quote), Allied Waste Industries (AW Quote), Georgia-Pacific (GP Quote) and Cendant (CD Quote) that have accumulated a great deal of goodwill on their balance sheets over the past few years. That's accountant-speak for the amount a company pays for another company over its book value because of expectations that some of its intangible assets -- such as patented technology, a prized brand name or desirable executives -- will prove valuable in a concrete, earnings-enhancing sort of way.

New Accounting Rules

Companies carry goodwill on their balance sheets as if it were an asset as solid as a piece of machinery, and therefore it is one of many items balanced against liabilities, such as long-term debt, to measure shareholder equity or book value. Just as hard assets are depreciated, or expensed, by a certain amount each year to account for their diminished value as they age, intangibles have long been amortized by a certain amount annually to account for their waning value. ...