Monday, June 06, 2011

Is Yahoo Undervalued?

Bloomberg reports that tech stocks are more undervalued than they've been since 1998. Moreover, hedge fund honcho, Greenlight Capital's David Einhorn, disclosed that he bought a big chunk of Yahoo (NASDAQ: YHOO) in April 2011. Should you follow Einhorn into Yahoo?

The case for investing in technology stocks is clear -- the value that investors assign to technology stocks has tumbled as their expected profit growth accelerates. Since stocks peaked on Feb. 18, tech stocks have lost $190 billion in market value, a 7% drop -- and they now trade at 9.3 times reported earnings before interest, taxes, depreciation and amortization (EBITDA), 1.3 times the index’s multiple -- the lowest ratio since at least 1998.

But analysts expect tech earnings to roar upwards. In 2011, technology earnings are expected to rise 35% faster than the S&P 500 index -- 24% vs. 17% for the S&P 500. This means that tech stocks trade at a P/E of 12.8 compared to 13.1 for the index.

Does this mean you should invest in technology stocks? To think about that, we can look at their price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

And on that basis, tech stocks are cheap -- trading at a PEG of 0.53.

Prospects for continued demand growth for technology look compelling. In the first quarter, despite anemic 1.8% GDP growth, investment in technology climbed 11.6%. And executives are boosting computer and software spending 10% in 2011, about four times faster than U.S. GDP.

Einhorn announced in April that he bought Yahoo shares because, according to Market Folly, he "likes the company's net cash position and [its[ 40% stake in Alibaba Group as a valuable asset."

But for its most recently quarterly report, Yahoo reported down earnings though not as bad as expected. In April, Yahoo said its first quarter profit ending in March 2011 fell 39% to $223 million from the previous year to 17 cents a share while its net revenue fell 6% to $1.06 billion. It beat EPS by a penny and its revenues fell $10 million short according to analysts that FactSet Research polled.

And Yahoo's guidance for its second quarter ending June 2011 were consistent with expectations. In April, it forecast that its revenue excluding traffic acquisition costs would range between $1.08 billion to $1.13 billion. Analysts had been expecting $1.1 billion.

But since then, Yahoo shareholders have faced bad news. On May 26, IDC reported that Google (NASDAQ: GOOG) took first place from Yahoo in U.S. display advertising market share. Specifically, in the first quarter of 2011, Google's share of the U.S. display ad market rose to 14.7% shrank from 13.6% to 12.3%.

So after Yahoo's stock has fallen 5.7% in 2011, is Einhorn right to buy it? Yahoo's PEG of 1.04 -- its P/E of 16.5 on earnings growth of 15.8% in 2012 to $0.91 -- suggests the stock is reasonably valued. But given its history of beating expectations by about 16% over the last four quarters, there is some catalyst for a price rise.

I just don't think the cost cutting that lets Yahoo boost earnings is enough to justify getting too excited about the upside potential in a company that's losing market share.


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