H-P ($HPQ) is an example of why you should be wary of acquisitions

If you are watching the news the last few weeks, you will have noticed that the current management team of Hewlett-Packard [stckqut]HPQ[/stckqut] is practically accusing the Autonomy management of lying. H-P management is saying that Autonomy was not worth what it paid for the company but the fault lies with Autonomy and not with H-P.

In my forthcoming book (hopefully on sale by Christmas), “The Confident Investor” I explain that investors should sit back and watch when a company makes a large acquisition.  Never own a company that sells more that 10% of itself (e.g. spins off a division) or buys another company that is larger than 10% of the original company (e.g. they acquire a company as a new division or subsidiary). These extraordinary events can radically change a company and divert its attention. While many such events will result in a stronger company, you cannot be confident in the short term that your investment is safe. It is usually safer to invest your money and time elsewhere while the dust settles.

The 10% rule of thumb is simply that, a rule of thumb. Sometimes you should be wary of a company making a smaller acquisition that is significantly above market value. Too often these deals include far too much goodwill and then that goodwill turns out to be bad.  In a recent Wall Street Journal article, “‘Tis No Season for Goodwill to Investors” it was pointed out that H-P is writing off more than $5B in goodwill for the Autonomy acquisition. They are not alone though since Microsoft [stckqut]MSFT[/stckqut] just did a $6.2B write-off and Bank of America [stckqut]BAC[/stckqut] a whopping $15.6B.

Sometimes, a major acquisition turns out well but you should always be wary. If one of your major holdings makes a significant acquisition there are a few quick steps to take. First, find out if the company is being praised by the business media. Typically, if the media is positive towards the acquisition then it isn’t terrible.  Second, do some quick analysis of the acquired company – would you invest in the company at the acquired price? If you are not sure how to establish a fair price then you really should read my forthcoming book as I spend time explaining how to value a company.

Not all acquisitions are bad but you should be wary of all acquisitions.

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