It pays to be skeptical of growth stocks that rely too heavily on acquisitions. That’s because the buyer of something rarely knows as much about it as the seller. So it follows that if a company makes enough acquisitions, it might eventually buy something that has hidden problems. At some point, those problems will come out into the open and hurt the buyer’s earnings.
Big acquisitions can mean big debts for growth stocks
Acquisitions, particularly big ones, can also push up debt, which leaves the buyer vulnerable to failure if it can’t meet the payments. They can also load the buyer’s balance sheet with goodwill, an intangible asset whose value can drop overnight if it turns out that the company made a bad acquisition. In that case the company has to write off all or part of the acquisition’s cost against current earnings. This can wipe out a year’s earnings for the growth stock and devastate its share price.
We keep all of these factors in mind when we analyze growth stocks in our Successful Investor newsletter.
In the latest issue of The Successful Investor, we update our views on grocery retailer Loblaw Companies Ltd. (Toronto symbol L). The company just made news on the acquisitions front.
Loblaw looks to a growing market
Loblaw has over 1,000 stores, which makes it Canada’s largest supermarket operator. Its major banners include Loblaws, Real Canadian Superstore, Provigo and Zehrs.
Last month, Loblaw agreed to buy the T&T supermarket chain for $225 million. Asian-food retailer T&T has 17 stores in B.C., Alberta and Ontario. The deal is expected to close later this year.
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The T&T purchase may work for Loblaw because of a number of different factors. First, Loblaw has $1.1 billion in cash, so it can easily afford to buy T&T without taking on extra debt. The acquisition’s small size also helps Loblaw cut its risk. While T&T is the country’s largest retailer of Asian foods, the chain’s 17 stores represent a small fraction of market-leader Loblaw’s 1,000 outlets. T&T is expected to add about $514 million to Loblaw’s annual sales of $7.2 billion.
Loblaw will run T&T as a separate division, but the growth stock’s expertise should make T&T more efficient and help it expand into new markets.
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