By Ahmed Ishtiaq
Yahoo! Inc (YHOO) has been resurgent in the past few months and the stock has gained substantially. Earnings and revenues are improving for the company. After changing five CEOs in the past five years, it looks like the company is finally on the right track under the leadership of Marissa Mayer. Employees and investors are equally optimistic about the future of the company. As a result, this internet behemoth has been showing signs of strength over the past six months. We decided to use our discounted earnings plus equity model to value the stock, and come up with a fair price.
As of February 01, 2013, Yahoo stock was trading at around $19.76, with a 52-week range of $14.35 - $20.88. It has a market cap of about $23 billion. The trailing twelve-month P/E ratio of 6.1 is lower than the forward P/E ratio of 15.80. P/B, P/S, and P/CF ratios stand at 1.5, 4.9, and 11.8, respectively. The operating margin is 12.5% while the net profit margin is 79.9%.
Yahoo has a 2-star rating from Morningstar. Out of ten analysts who are covering the stock, three have a buy recommendation, four have a hold recommendation, and only one analyst has an underperform rating for the stock. Average five-year annualized growth forecast estimate is 13.27%.
We can estimate Yahoo's fair value using the discounted earnings plus equity model as follows.
Discounted Earnings plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5+ Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.
In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year. The average EPS for Yahoo is $1.13.
While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 13.27%. Book value per share is $12.35.
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Yahoo is between $18.50 and $30.85 per share. At a price of about $19.76, Yahoo is trading close to the lower boundary of its fair value range. The stock still has up to 56% upside potential to reach its fair value maximum.
Yahoo has shown substantial recovery, and the earnings of the company have been improving over the past year. There was a slight improvement in revenues, and adjusted earnings of $0.23 per share were below the average analyst estimates of $0.27. However, adjusted earnings included a write off of its Korean operations; without the adjustment, earnings would be $0.32 per share. Nevertheless, there is still a long way to go for this giant to get back on its feet and start running. A number of bad events, such as rapid changes at top management level, poor management and lack of focus on innovation have caused the company to fall behind its competition. Its growth rate is far less than its competitors, and Yahoo is not exploiting the growth opportunity in the market.
Yahoo has benefited recently from increased ad prices and international investments. Recovery in earnings is encouraging for the company; however, earnings growth rate is still considerably lower than that of industry. Nonetheless, there are signs that the company is making a serious turnaround, and it will be able to achieve previous highs. According to our model, there is a lot of potential in the stock, and it can be a great investment.