Capitulation . That's an often-used word on Wall Street to
describe when investors completely give up and throw in the towel.
It's not always a bad thing: Some investors love to find situations
where a stock has been so crushed that shares are taking a final
beating as the last remaining bulls exit a stock.
And that's what happening with
Yahoo! (Nasdaq: YHOO)
on Wednesday. Shares are off nearly -10% after another dismal
earnings report, briefly touching lows not seen since 2003 (with
the exception of the early 2009 market swoon).
Yahoo is surely having a tough go of it. Sales hardly budged in
2008, fell -10% in 2009, and are only barely growing in the first
half of 2010, even as rivals are starting to benefit from an
improving economy. That's why Google
is worth more than eight times Yahoo.
And even though Yahoo's top-line results disappointed, it's worth
noting that +2% year-over-year sales growth marks the fifth
straight quarter of improvements. (Yahoo's sales had been falling
at a double-digit clip last summer).
Despite those woes, investors should also take note of the
positives. For example, the company has figured out ways to lower
its costs to provide content to users, pushing operating margins up
more than 200 basis points in the most recent quarter to around
11%. And that allowed
to more than double and net earnings to grow +53% from a year ago.
Management sees further gains ahead. Operating margins could
approach 15% by 2012, and 20% by 2013, according to management
targets. Yahoo may not be a great sales growth story, but it's
shaping up to be an excellent profit growth story. Profits should
rise at least +20% this year, and if some progress is made on that
target, profits should rise another +20% in 2011 and 2012 -- even
if sales growth is flat.
And Yahoo's cash pile remains hefty at a recent $3.8 billion ($2.71
a share), which is, as you might guess, going toward stock
buybacks. The company bought $385 million in stock in the first
quarter, $496 million in the second quarter. And the company's
board authorized a fresh $3 billion stock buyback plan at the end
of June. If completed, that would reduce the share count by -15%,
boosting earnings per share by a commensurate amount. Any margin
expansion would only extend profit gains.
Most important, Yahoo's search engine remains relevant. The number
of searches conducted rose +7% from a year ago. And as long as
Yahoo remains as a key player in the search field, it always has a
shot at regaining luster against Google if it can tweak its site
for improved results or enhanced features. In effect, don't count
Yahoo out, even though its share price tells you that you
Action to Take -->
As Yahoo's profits rise and its stock sinks, the company's
price-to-earnings ratio (P/E)
gets smaller and smaller. If you exclude the company's cash
balance, then shares trade for around 11 times potential 2012
profits of $1 a share. Again, that forecast assumes zero revenue
growth. But economists still think that the economy will eventually
be back on the mend. Which is always a good thing for
advertising-related businesses like Yahoo.
Realistically, Yahoo would be of greatest value to another
technology giant. We won't re-hash the value of a potential link up
with the likes of
Microsoft (Nasdaq: MSFT)
, as that ship has sailed (and sailed and sailed). At some point,
Yahoo's board will realize that its growth opportunities can be
better exploited in the hands of another player.
For now, the company must simply keep expanding profit margins,
keep buying back stock, and keep tinkering with its content
strategy. That approach isn't finding favor with investors right
now, but this company is far healthier than the dismal stock price
-- David Sterman
David Sterman has worked as an investment analyst for nearly two
decades. He started his career in equity research at Smith Barney,
culminating in a position as Senior Analyst covering European
banks. David has also served as Director of Research at Individual
Investor and has made numerous media appearances over the years,
primarily on CNBC and Bloomberg TV. David has a master's degree in
management from Georgia Tech. Read More...
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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