Technology stocks are built on innovation. Over the last decade, we have seen so many changes in the business structure of technology stocks that being static means a decrease in corporate earnings and, ultimately, death. Yahoo! Inc. (NASDAQ/YHOO) brought in new CEO Scott Thompson to try to turn its fortunes around. We have seen a slow decline in Yahoo!’s corporate earnings and market share versus other technology stocks over the past decade. Thompson has a huge mountain to climb.
He declared that his goal is to see 20% annual revenue growth for Yahoo! The latest earnings results from Yahoo! show just a one percent increase in revenue, although profit is expected to rise 28%. Yahoo! is strange among technology stocks in that most of the value of Yahoo! USA is built on Alibaba and Yahoo! Japan. I do applaud management at Yahoo! for the recent cost-cutting, which is helping to increase corporate earnings; but cost-cutting does not mean revenue growth. Technology stocks need to continue to innovate if they are to grow revenue and corporate earnings, which are the ultimate criteria for investors over the long term. While it’s great to have corporate earnings increase through cost-cutting, at some point, revenue needs to grow to sustain the increase in corporate earnings. There is a level at which you can’t cut anymore, because you’ve already reduced all excess fat and there’s nothing left to cut.
While Thompson is confident, the question is: what is a strategy for Yahoo!’s corporate earnings growth over the next decade? While Thompson indicated he would like to move more aggressively onto mobile phones, where we’ve seen a lot of growth from other technology stocks, not much is outlined as to how to accomplish this transition. Of the $20.0-billion market value for Yahoo!, I would say approximately $18.0 billion is for the Alibaba and Yahoo! Japan portion. There have been some suitors in the form of other technology stocks in the past, as I wrote in the article Will Microsoft Attempt to Buy Yahoo Again? The other positive for the stock that might entice a buyer is the fact that it has over $2.0 billion in cash. Investing in Yahoo! is certainly different than other technology stocks, as you are betting on monetizing the other parts of the business and not on corporate earnings growth.
The current valuation has a price to earnings ratio of almost 19, and a price/earnings to growth ratio of 1.71. Frankly, you’re not paying for this growth, because there isn’t much, as compared to other technology stocks, but rather are hoping for a sale or split of the company. Revenue from display portion dropped four percent in the first quarter, and I don’t see that changing anytime soon. I can’t argue with the logic hoping for a sale, at the current price level there isn’t much downside. On the other hand, the funds invested could be dead money for a long period of time, when you could be investing in technology stocks with much bigger growth potential.
To summarize, Yahoo! is a company that has declining revenue, a questionable corporate earnings growth strategy, and extreme competition from Google Inc. (NASDAQ/GOOG) and Facebook. That is a very difficult task at the best of times. With technology stocks as competitors like Google and Facebook that can out-muscle, outspend and frankly out-engineer Yahoo!, as an investor I would be hoping for a sale fairly soon. With Yahoo! stating that revenues for the second quarter is to be estimated down approximately 11%, I believe that Thompson is making the recent job cuts to make the firm look pretty for a sale. A leaner organization is easier to sell; the one resolution that many investors are hoping for.