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The 3 Dirtiest Words in Investing

These three abused terms could be hiding some red flags

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Take Netflix (NASDAQ:NFLX), for instance. You know how it pays studios and distributors for all those television shows and movies available at its site, and then resells the digital content at a (hopefully) higher price to its subscribers? Interesting twist here … it knows what kind of minimum financial obligation it’s got in the pipeline for upcoming features. But, since those movies and shows aren’t yet available online, Netflix doesn’t have to post the dollar amount of those upcoming commitments.

Care to guess the price tag of upcoming content? It’s a whopping $3.7 billion, though you’d have to read the fine print and footnotes from the recent SEC filings to know it — you know, since it’s “off balance sheet.” And this is a problem, since the company only generated $3.2 billion in revenue last year, and only cleared $226 million in profit.

Fans of Netflix rightfully point out that the top line’s getting bigger at a rapid pace. Unfortunately, the expense lines are rising even faster. And that $3.7 billion obligation is only a minimum. The final bill could be much bigger.

3. Goodwill

Although a charge to “goodwill” is a subset of the term “non-cash charge,” it deserves some special attention of its own.

In simplest terms (and as defined by, goodwill is an “intangible asset which provides a competitive advantage, such as a strong brand, reputation, or high employee morale.” Needless to say, the judgment-call aspect of goodwill has made it something of an off-the-radar slush fund for major corporation, particularly when it overpays for an acquisition.

The good/bad news is that even assets being held in the goodwill bucket are subject to periodic valuation tests.

Microsoft (NASDAQ:MSFT) investors know that all too well. The software giant recently took a $6.2 billion charge — taken out of the listed value of goodwill — to wash its hands of aQuantive. Microsoft purchased Aquantive back in 2007 at a price of $6.2 billion, hoping the company would improve its online advertising business.

It didn’t. In fact, Microsoft lost money trying to make it work. Finally realizing it was a lost cause, the company file-13’d it last quarter, and reduced its goodwill balance by the purchase amount.

But if it’s a non-cash charge to goodwill, why should investors care? Because it still ultimately cost shareholders money. It just started to cost them money back in 2007, when the company wrote the check for the acquisition. Investors didn’t care so much when the cash became an asset, because it all still was under the Microsoft umbrella (and the asset was expected to be income-producing). Now it’s neither an asset nor cash.

Bottom Line

These aren’t the only words that raise red flags for investors, but they seem to be the three most abused. When you start to see them associated with companies you own, it’s time to start asking questions.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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