The ModernGraham approach to investing has multiple layers to it. Regular readers will be familiar with the first two steps; the first is to determine if the company is suitable for the Defensive Investor or the Enterprising Investor, and the second is to compare the price to the intrinsic value through quantitative analysis. The next step in the analysis is to review the company’s management and other qualitative factors to determine how the company may compare to other companies that pass the first two steps. In this Company of the Week series, we will delve into more detail about a specific company that performed well in the first two areas. This week, the company chosen, Yahoo! Inc., is currently significantly undervalued based on the ModernGraham valuation model.
Results of Recent Valuation
Please be sure to review ModernGraham’s latest valuation of Coach Inc. in detail, but here is also a summary:
Yahoo Inc. is suitable for Enterprising Investors but not Defensive Investors. The Defensive Investor is concerned with the lack of dividend payments as well as the high PEmg and PB ratios. The Enterprising Investor is also concerned with the lack of dividend payments, but the company passes all of the investor type’s other requirements. As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with further research into the company and its competitors, including a review of Microsoft Corp (MSFT) and Google Inc. (GOOG). As for the valuation, the company appears to be undervalued after growing its EPSmg (normalized earnings) from $0.57 in 2010 to an estimated $1.54 for 2014. This level of demonstrated growth is greater than the market’s implied estimate of 6.60% earnings growth and leads the ModernGraham valuation model to return an estimate of intrinsic value that is well above the market price.
Price trend compared to the market
In the following chart, it is clear that in the past 18 months the company has seen a very strong rise in price from Mr. Market, but over the long-term view the company continues to trail the market overall. This is in line with some of the business struggles Yahoo has seen over the last ten years (primarily increased competition in the rise of Google), but it does show that Mr. Market is responding very quickly to recent changes. Intelligent Investors know that the price trend has nothing to do with value, but this portion of an analysis can be useful in trying to understand Mr. Market’s movements.
Earnings Per Share
The next chart shows Yahoo’s earnings over the last 10 years. Overall the earnings would appear to have been someone flat, but there certainly has been a slow rise. In addition, it is always important to take into consideration average earnings rather than earnings from a single year. On ModernGraham, we utilize a weighted average of the last five years (called EPSmg). With Yahoo, that figure has risen from $0.47 in 2009 to a peak of $1.61 in 2013 and is only expected to dip to $1.54 for 2014. This is a strong level of demonstrated growth that could be very profitable if the company can continue to maintain it.
Price to Book
In one final confirmation that Yahoo would seem to be an excellent value at this point in time, the price to book ratio is well below where it has normally been seen in the last 10 years, though it is higher than it has been in most of the last 5 years. As a result, it is possible we could see Mr. Market turn around and start pricing the company higher.
Yahoo is a very intriguing company for Enterprising Investors to consider. In addition, the quantitative analysis shows the company to be significantly undervalued, though the lack of dividends is frustrating to value investors. It is possible that Mr. Market has overreacted to any perceived troubles the company has had in the recent past, speculating that the company had been overrun by more recent tech startups. However, as has been seen time and time again, large companies often have the resources to weather the ebbs and flows of business competition and that may be the case with Yahoo as well.
Warren Buffett has promoted looking at some key management tenets, and I’d like to leave it up to readers to discuss how Yahoo! fulfills (or fails to fulfill) these qualities. Please discuss the following in the comments below:
- Is the business simple and understandable?
- Does the business have a consistent operating history?
- Does the company have favorable long-term prospects?
- Is management rational?
- Is management candid with shareholders?
Disclosure: The author did not hold a position in any company mentioned in the article at the time of publication and had no intention of changing that position within the next 72 hours.