Sometimes one company decides to buy another or merge with another. If a company acquires another company or merges during the year the annual report covers, a note to the financial statements is dedicated to the financial implications of that transaction. In this note, you see information about
The market value of the company purchased
The amount paid for the company
Any exchange of stock involved in the transaction
The transaction's impact on the bottom line
When a company acquires another company, it frequently pays more for that acquisition than for the total value of the purchased company's assets. The additional money spent to buy the firm falls into the line item called Goodwill.
Goodwill includes added value for customer base, brand name, locations, customer loyalty, and intangible factors that increase a business's value. If a company has goodwill built over the years from previous mergers or acquisitions, you see that indicated on the balance sheet as an asset.
In an acquisition, the acquired company's net income is added to the parent company's bottom line. This addition occurs even if the closing of the sale takes place at the end of the year. Many times, this addition can inflate the bottom line and make the net income look better than it actually will be when the companies are fully merged.
Be sure to look closely at the impact any mergers, acquisitions, or even sales of parts of an acquired company have on net income.
A merger or acquisition may positively impact the bottom line for a year or two, and then the company's performance drops dramatically as it sorts out various issues regarding overlapping operations and staff. Many times, the announcement of a merger or acquisition generates excitement, causing stock prices to skyrocket temporarily before dropping back to a more realistic value.
Don't get caught up in the short-term euphoria of a merger or acquisition when you're considering the purchase of stocks. Read the details in the notes to the financial statements to find out more about the true impacts of the merger or acquisition transaction.
