So the stock market is crashing.  Is now the time to buy?  Many CEOs are asking this question. 

The problem is that too often people try to buy a company that’s "cheap", using its past history as the basis.  Take Bank of America (see chart here).  BofA earlier this year bought the most troubled of all the mortgage companies Countrywide Financial.  And then when Lehman Brothers was falling into bankruptcy BofA purchased Merrill Lynch,  a retail stock brokerage that has been realing from on-line competition since e*Trade started in the 1990s, has one of the weakest mutual fund departments, one of the weakest research departments and a weak investment bank.  BofA’s view was that based upon history, these companies were very cheap.  But now, shortly after the acquisitions, BofA is announcing that it must halve its dividend, and raise additional equity through a new stock sale in order to shore up its balance sheet.  And on top of this, earnings are down for the quarter and the year as the CEO starts claiming that estimates are pretty meaningless (read article here).  Should you buy the new stock offering?

When markets shift, the value of assets tied to old Success Formulas decline.  In the new market, the old Success Formula produces weaker returns and thus it is worth less.  Too many people see this lower value as being a chance to "buy on the cheap."  But far too often value will continue to decline because the old business simply isn’t worth as much.  In Bank of America’s case, it bought extremely large players, but those that are inexorably linked to the old markets with old Success Formulas that are fast becoming out of date.  While Merrill Lynch may be a great old name, the company itself has never been able to produce its old level of returns since brokerage markets shifted over a decade ago.  Increasingly, it looks like BofA simply bought out-of-date competitors that were finding themselves on the rope as this market shift happened.  And the BofA leadership is even leaving the old leaders in place after the acquisition.

Just in case you think that all the strategy and finance brains in big corporations means they are better judges of company value than yourself, remember that very rarely does any acquisition become worth what it cost.  All finance academicians point out that buyers overvalue acquisitions in the process. In the end, it’s the buyers that see valuations suffer due to lower than anticipated earnings.  In this case, BofA has bought large – but weak – competitors in markets reeling from shifts.  And BofA has shown no proclivity to take dramatic changes to alter the Success Formulas (which JPMorgan Chase did upon acquiring Bear Sterns for almost nothing).  This is a recipe for weak future performance.

Those companies that will benefit from acquisitions in this turmoil will have to purchase companies that better position the acquirers for future growth.  Leaders not necessarily in size, but in the ability to produce growing revenues and profits.  And acquisitions which can help migrate the acquirer’s Success Formula forward toward better competitiveness and higher returns – not just adding immediate (but declining) revenue.  What’s going on at BofA may look like an effort to "buy on the cheap," but it’s more likely to end up "a pig in a poke."