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Why Yahoo!'s dive may be good news
Great expectations and disappointing results have Yahoo! shares reeling. But if the stock falls further, it will be time to buy.
By Robert Walberg
Yahoo!s fourth quarter earnings report will have investors scratching their heads as they watch todays tape action. What investors will hear is that Yahoo!s year-over-year revenues surged 36%, with earnings up by a generous 32%. What they will see is the stock dropping by more than 10%.
The difference between the companys performance and the stock's performance comes down to one word -- expectations. Yahoo! (YHOO, news, msgs) has a track record of exceeding Wall Street expectations. Not this time. Earnings, though up considerably, fell short of the consensus view by one penny a share. That single little pennys difference is responsible for the near $7 billion hit to the Yahoo!s stock-market capitalization.
That is why it is just as important to understand the expectations game as it is to understand corporate financials. Billions can be lost because a company fails to do what analysts expect. It's the same reason investors need to be careful when a stock has a great run heading into its earnings report. The risks -- at least on a short-term basis -- increase significantly.
Next up: Google
A couple of weeks ago I suggested that it was time to sell Google (GOOG, news, msgs) shares due to the fact that nearly every analyst was in love with the stock, making it virtually impossible for the company to live up to expectations. Googles stock continued to climb, but whats happening to Yahoo! should serve notice to Google investors.
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Lofty expectations and lofty valuations are closely linked. As the crowd starts to fall in love with a stock and its story, the share price rises -- in the case of Yahoo! the stock jumped a whopping 38% from late September to late last week. Put another way, Yahoo!s market cap over the last few months soared by more than $17 billion -- nearly the equivalent of Amazon.coms (AMZN, news, msgs) total market cap.
Yahoo! closed Tuesdays session trading at 53 times estimated fiscal-year 2006 earnings of 76 cents. Considering its impressive mid-30% growth rates, such a multiple might be acceptable -- as long as the company didnt do or say anything to alter the euphoric view on the Street. Such as missing its earnings number.
Getting growth, at a discount
Before getting overly concerned about Yahoo!s fate, lets remember that the company grew its business at a very brisk pace and theres nothing on the horizon to suggest that the business will slow considerably.
Failing to meet this quarters expectations doesnt mean that the company is losing its momentum. There arent many companies out there Yahoo!s size that are continuing to grow sales, earnings, operating income and free cash flow by better than 35%. This is simply a case of the stock climbing too far too fast and needing to take a break. Expectations will now be adjusted to reflect the possibility that increased competition and the natural maturation of the company might translate into an earnings hiccup every now and then.
Thats not a bad thing, especially when if the stock loses some of the excess created by the recent surge in demand for Internet-service stocks Yahoo! is still a formidable company delivering impressive results across the board. Let the earnings miss shake out the momentum traders, and let the stock settle down a bit. If you can pick shares of this Internet leader up in the $31-$32 range then do it, as the short-term miss is creating a nice long-term opportunity to own a quality company at a much more affordable price.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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