💲𝙄𝙢𝙥𝙖𝙞𝙧𝙢𝙚𝙣𝙩 𝙣𝙖𝙘𝙝 𝙄𝘼𝙎 36 𝙠𝙪𝙧𝙯 𝙚𝙧𝙠𝙡ä𝙧𝙩💲
𝑮𝒆𝒇𝒂𝒉𝒓𝒆𝒏 𝒗𝒐𝒏 𝑮𝒆𝒘𝒊𝒏𝒏𝒆𝒊𝒏𝒃𝒓ü𝒄𝒉𝒆𝒏 𝒖𝒏𝒅 𝒘𝒊𝒆 𝒊𝒉𝒓 𝒅𝒊𝒆𝒔𝒆 𝒇𝒓ü𝒉𝒛𝒆𝒊𝒕𝒊𝒈 𝒂𝒃𝒔𝒄𝒉ä𝒕𝒛𝒆𝒏 𝒌ö𝒏𝒏𝒕!
Especially in the current environment, it's important to understand what stagnant or even declining economic growth can mean for businesses. Clearly, valuations are adjusted and sales, as well as profit slumps can be the result. The consequences are falling share prices!
Therefore, a fundamental analysis has become all the more important. I therefore refer first of all to my ratio analysis, which gives you important tools:
https://app.getquin.com/activity/XcuRrJwmyP
But what is this IAS 36 all about?
Most European listed companies prepare their accounts in accordance with IFRS. IFRS requires that assets be measured on the basis of an annual impairment test. The exact rules for impairment are regulated in IAS 36 (A standard from IFRS). This IAS 36 is very essential and allows you to classify future events at an early stage. Therefore, I would like to explain to you as briefly as possible and in a comprehensible way what consequences these regulations can have for us private shareholders!
𝗜. 𝗜𝗔𝗦 𝟯𝟲 𝗶𝗻 𝗞ü𝗿𝘇𝗲
IAS 36 is a component of the IFRS framework, according to which most groups in Europe prepare their accounts. IAS = International Accounting Standard. But for you, the standard in this context should equally mean IAS =. "I Am Assed". Because if this standard "IAS 36" is applied, this always means a correction of the profit and thus probably also of the share price (depending on the magnitude)!
Core statement IAS 36: "The assets falling within the scope (in particular intangible assets and property, plant and equipment) shall be assessed at each balance sheet date for indications of impairment. If there are any such indications, an impairment test shall be performed." [1] This also requires an additional test during the year in the case of exceptional indications ("triggering events") (IAS 36.12).
Thus, an entity must analyze possible indications of whether an asset is impaired at least at each reporting date. IAS 36 contains a list of external and internal indicators of possible impairment. A mandatory annual review is required for intangible assets with indefinite useful lives, intangible assets not yet available for use and goodwill (IAS 36.10 and
IAS 36.90). [2]
The analogous requirements for accounting under U.S. generally accepted accounting principles (U.S. GAAP) are contained in ASC 350 Intangibles - Goodwill and Other and ASC 360 Porperty, Plant and Equipment. [2]
IAS 36 is applicable in particular to the following assets.
- Land
- Buildings
- Investment property measured at cost
- Intangible assets
- Goodwill
- Investments in subsidiaries and joint ventures.
Consequently, for all these balance sheet assets, an annual assessment must be made as to whether an impairment loss is required, and thus whether a write-down is required that affects profit!
𝗜𝗜. 𝗜𝗔𝗦 𝟯𝟲 𝗕𝗲𝗶𝘀𝗽𝗶𝗲𝗹𝗲 𝘂𝗻𝗱 𝗔𝗻𝗵𝗮𝗹𝘁𝘀𝗽𝘂𝗻𝗸𝘁𝗲 𝗳ü𝗿 𝗣𝗿𝗶𝘃𝗮𝘁𝗶𝗻𝘃𝗲𝘀𝘁𝗼𝗿𝗲𝗻
But how can I think of this exactly? How can we succinctly identify when impairment is at risk without performing an impairment test ourselves for each asset, which we often simply lack the data to do? After all, such an impairment would possibly result in a drop in profits, which would be reflected in the share price!
a) Market capitalization as the first indicator of impairment
Actually, only little information is needed for this:
1) Market capitalization (number of shares x price)
2) Shareholders' equity of the Group, as shown in the annual report.
You may be familiar with these two points, because these are exactly the parameters we need to calculate the price-to-book ratio (P/B).
If this ratio is less than 1, it does not immediately mean that the company is favorably valued. It also gives us an indication of whether there is a risk of impairment, which means that assets have to be written down in accordance with IAS 36. A ratio of less than 1 indicates that the book values are higher than the actual value on the stock market. Only if the stock exchange or the market just overlooks parameters does this justify a favorable time to buy.
This is because the core statement from IFRS (and also US GAAP) is basically that the financial statements must present the net assets, financial position and results of operations as well as the cash flows of a company in accordance with the actual circumstances [1]. This is referred to as the "true and fair view" concept. Many assets must therefore always be valued (using the DCF model, among other things). Thus, the pure market capitalization or the P/B ratio also gives us the first indications that need to be assessed.
Of course, a low KBV does not immediately mean impairment risk.
If you are interested in studies in this area, I can give you a closer look at the following. Here, stocks from the DAX, MDAX, SDAX and TecDAX were analyzed on the basis of market capitalization and equity in connection with possible impairment risks. Maybe you will understand better what I mean.
b) Goodwill
Investments in subsidiaries are not accounted for in group reports that we analyze (keyword "consolidation of investments" - if you want to know why). What we see in the group report is the so-called goodwill. Goodwill, in short, is the value that I am willing to pay extra for another company - thus going beyond the value of the book value of equity - because I think the company will be worth more in the future than what is on the books. This "premium" must be accounted for. The counterpart is the so-called badwill. Goodwill can be found under intangible assets in the balance sheet.
If a group has a very high proportion of goodwill in its balance sheet as a result of many company acquisitions, you must take this into account in your analysis! A high proportion of goodwill also means a high risk of extraordinary write-downs in periods of recession, which can have a 100% impact on profits! This would result in an impairment according to IAS 36.
Already in 2022, goodwill impairments have more than doubled, as the following study shows, which analyzed US based companies. The study names many reasons, including the decline in market capitalization (see my comments under point a), lower operating profits or even a reduction in the workforce.
Further examples based on current news, among others Canopy Growth:
For more details on Goodwill, I refer you to the following post as well as an image attached:
https://app.getquin.com/activity/ymidZwhlTk
In the comments, I also link to an analysis by AMD. Goodwill is also briefly discussed there. It becomes relevant here from minute 11.
c) Further examples
Other assets that can be valued well using a DCF model and can thus run into impairment under IAS 36 (list is not exhaustive and reflects own thinking):
-leased real estate - rent as the basis of cash flow for DCF (property, plant and equipment on the balance sheet)
-parking garages - parking fees as the basis of cash flow for DCF (property, plant and equipment in the balance sheet)
-Patents, rights for products - cash flow from product sales as basis of cash flow for DCF (intangible assets in the balance sheet)
In the same way, however, a dilapidated building in need of renovation or simply a building destroyed by external influences (environmental catastrophes, hurricanes, etc.) would be reason enough to depreciate it in accordance with IAS 36. Such "ad hoc" events are referred to as "triggering events", which also lead to impairments during the year.
d) Indications according to IAS 36
IAS 36 lists various indications that may lead to impairment:
External sources of information:
- the fair value of an asset has declined significantly during the period under review compared to its
use during the period under review (IAS 36.12 a));
- Significant changes in the technical, market, economic or legal environment of the entity (already occurred or imminent) (IAS 36.12 a).
market, economic or legal environment (IAS 36.12 b));
- increase in the market interest rates and yields on which the discounting of cash flows is based in the context of the impairment test (IAS 36.12 c)); -->very relevant in the current environment of rising interest rates!
- In the case of listed companies, the market capitalization (number of shares in
number of shares outstanding x price per share) is less than net assets (at book values)
(IAS 36.12 d)). -->see point a)
Internal sources of information:
- Substantial evidence of obsolescence or physical damage to an asset.
asset (IAS 36.12 e));
- significant changes with an adverse effect on the entity and the related asset (goodwill) (IAS 36.12 f));
- indications from internal reporting that suggest a worse (than expected) economic performance (IAS 36.12 g)).
𝗜𝗜𝗜. 𝗦𝗰𝗵𝗹𝘂𝘀𝘀𝘄𝗼𝗿𝘁
In short, recessionary periods and extraordinary events, such as the Corona Pandemic or environmental disasters are periods that can lead to significant impairment tests! Some of these we cannot predict. Others, however, such as the coming downturns in the course of a recession, we can! You do not need to understand IAS 36 in detail. However, you should know the consequences and be able to classify them!
Oh yes...sorry for the nerdy meme...🌝
Sources:
[1] IFRS Visuell - The IFRS in structured overviews, 7th ed.
[2] https://www.firicon.de/ias-36-wertminderung-von-vermoegenswerten-impairment-test.html
other sources:
Goodwill ratios DAX companies: https://www.brokervergleich.de/wissen/expertisen/goodwill-bei-dax-unternehmen/
KBV DAX: https://www.boersengefluester.de/10-jahres-durchschnitt-kgv-kbv-dividendenrendite/
