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Published: July 21, 2010
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 (Nasdaq: GOOG) 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
operating income 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
operating margin 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 should.
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 action indicates.
-- David Sterman
Staff Writer
StreetAuthority |
