Why do Financials have low Goodwill?

Goodwill is an intangible asset that arises when a company acquires another business for more than the value of its identifiable assets and liabilities. This premium reflects factors such as brand reputation, customer relationships, and intellectual property. Our 2017 analysis of S&P 500 companies highlighted significant differences in goodwill across various sectors, with Financials exhibiting particularly low levels of goodwill. In this article, we explore why the financial sector tends to have low goodwill and how fintech companies like Revolut might be poised to change this trend.

Our analysis revealed that sectors like Consumer Discretionary, Utilities, Information Technology, and Healthcare have high levels of goodwill. These sectors rely heavily on intangible assets like brand strength, customer loyalty, and intellectual property. High levels of goodwill in these sectors indicate significant investments in innovation and strategic acquisitions to maintain competitive advantages. Conversely, the Financials sector, along with Real Estate and Telecommunication Services, shows lower levels of goodwill, reflecting a different set of business dynamics.

Several factors contribute to the Financials sector’s low levels of goodwill. Firstly, financial institutions typically have significant tangible assets, such as loans and real estate, which overshadow their intangible assets. The nature of their business involves substantial physical and financial holdings that do not contribute to goodwill in the same way as brands or intellectual property do. Secondly, the financial sector is heavily regulated, which can limit the scope for innovative, intangible asset development. Strict regulations focus on financial stability and risk management, leaving less room for the kind of strategic acquisitions that generate high goodwill.

Additionally, many financial services are commoditized, meaning that banks and financial institutions often compete on price rather than unique value propositions. This commoditization reduces the opportunity for significant brand differentiation and customer loyalty, which are key drivers of goodwill. Furthermore, financial institutions are often conservative with their acquisition strategies, focusing on mergers and acquisitions that offer clear, tangible benefits and synergies rather than those driven by intangible assets. This approach results in lower levels of goodwill.

Fintech companies like Revolut are challenging the traditional financial sector's approach to goodwill. Revolut, a digital banking app, has built significant brand value through innovation, customer-centric services, and strategic acquisitions. By focusing on seamless digital experiences, Revolut differentiates itself from traditional banks, creating substantial intangible assets in the process. Revolut’s strong brand is built on offering a user-friendly digital banking experience, which has garnered a loyal customer base. This brand strength is a significant contributor to goodwill. Continuous innovation, such as introducing cryptocurrency trading and budget management tools, enhances customer relationships and drives goodwill. Additionally, Revolut’s acquisition of startups with advanced technologies adds to its intangible asset base, increasing goodwill. These strategies demonstrate how fintechs are disrupting traditional financial models, potentially leading to higher goodwill in the financial sector. By leveraging technology and focusing on customer experience, fintech companies can build the kind of intangible assets that generate goodwill.

While forecasting goodwill presents challenges due to its intangible and subjective nature, advancements in data science offer new possibilities. Machine learning algorithms and predictive analytics can analyze large datasets to identify trends and patterns, making goodwill forecasting more accurate. Incorporating goodwill forecasts into financial planning helps companies optimize their acquisition strategies, improve resource allocation, and make informed investment decisions. Accurate goodwill forecasts can enhance strategic planning, provide valuable investor insights, and improve overall company valuations, leading to smarter, more resilient portfolios.