Yes, you read that title correctly - Yahoo (NASDAQ:YHOO), the very company that many investors deemed dead for the past three years, is a terrific value play heading into the next two years. Don't believe me? Here's why.
An Ugly Few Years
Remember when the entire stock market fell apart in 2008? Shares of YHOO lost nearly 65% of their value that year, but as the broader market recovered, YHOO continued to flounder, hampered by lack of vision, poor leadership, no differentiation, and a confused business offering. The stock traded in a $6 range for the most part between the lows of 2008 and October 2012. For the company, which was once a pioneer of the Internet generation, the future looked bleak for a long time heading into last fall.
A Catalyst and a Rebound
Since October, shares of the company have risen an astonishing 58% to the current trading level of $25, but despite the rise the company is still deeply undervalued. The strength in stock price needed to improve to attract any type of bullish investor to the stock - before October there was no reason to believe that the stock was moving higher and therefore no reason for investors to commit new money. The catalyst, though, came with the hiring of new CEO Marissa Mayer in mid-July. Her experience as a leading executive at Google (NASDAQ:GOOG) was welcome to the faltering YHOO, who after competing for search engine prominence with GOOG for years had become the lowly younger brother more recently.
Fundamentals & Earnings Performance Strengthening
As soon as Mayer came on board at YHOO, she made it clear that the company needed to become a much more efficient machine to rejuvenate the business model while maximizing profitability. When Q1 2013 earnings were released just a week ago, one of the most interesting figures was that the company trimmed the workforce by 19% in the quarter, year over year. From an earnings perspective, the company reported quarterly EPS of $0.38, which beat the Street's expectations by $0.14, or 58%. YHOO reported revenues ex-TAC and adjusted EBITDA even with Q1 2012, while doubling its cash and marketable securities, year over year. Finally, the company repurchased $775 million in stock during Q1 and plans to repurchase an additional $778 million this year.
Financial strength has significantly improved since early 2012, when many investors speculated that YHOO could be a takeover target. Mayer's leadership has proven effective and she's catalyzed a renewed confidence in the company, something investors haven't seen since 2006.
Intrinsic Valuation Shows Deep Value
We'll use the revised Benjamin Graham formula to assess the intrinsic valuation of shares of YHOO. There is credence in this model because it is both reflective and forward looking, and it takes into account the broader market as well as specific company details.
Intrinsic Value = [EPS(TTM) x (8.5 + 2g) x 4.4] / Y
EPS: the model uses the EPS during the trailing twelve months
8.5: constant represents industry-average P/E Ratio for no-growth company
g: the company's forward-looking (5 year) growth forecast
4.4: the average yield of high-grade corporate bonds during Graham's launch of the model
Y: current yield of AAA corporate bonds
Below is the analysis of four major computer services stocks. Though each company operates in multiple different business segments, it provides a clear picture of the value landscape and why YHOO is a top investment, especially within this particular industry.
A Relative Graham Value over 1 indicates that the stock is trading below its intrinsic value. Likewise, a stock with a RGV less than 1 indicates overvalue, in which case a pure value investor would decide not to make an investment.
Of course there are flaws in the method, as there are with all valuation methods. For one, the forward-looking projections are just that - projections. They're not grounded in fact but instead devised by analysts, so there is no certainty that those projections are correct. Even so, the future growth projections play a much smaller role in the valuation than the previous year's EPS and the broader market conditions.
YHOO is currently undervalued by 27% according to the Benjamin Graham Valuation method, despite the 58% rise in shares during the past six months. The model tells us that there are still sufficient gains to be made. YTD the stock has moved well along a positive trend line, touching or coming close four times. The price is currently $1.25 above the trend, so investors can begin accumulating at these levels and add to their position on any dip. Target price for fair value is $33.90.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.