Yahoo CEO Jerry Yang is stepping down and Carol Bartz has taken the reins as the company's new CEO. Most hope that she can fix Yahoo and return it to the place of dominance it once enjoyed. Or failing that, at least move it back into favor with shareholders. This will be difficult. The company was shaken by two rounds of layoffs during 2008 and a near shareholder coup over its treatment of Microsoft's acquisition bid, which contributed to its 59 percent stock price decline from its 2008 high of $30 per share to its current $12.31 per share (a $17 billion market cap).
But if you look at the Yahoo balance sheet, its stock is still overvalued, and, needless to say, Bartz has some difficult work in front of her to turn Yahoo around. Here's why. (Note that all the findings below are derived from Yahoo's 2007 Annual Report and 2008 third-quarter data. The company plans to release 2008 fourth-quarter data on January 27.)
Cash: Ideal. Income: Declining
When evaluating the financial health of a company and determining whether or not you should invest your money in its stock, it's best to start with the easy figures, income and cash. And in that department, Yahoo, while still healthy, has hit some troubling times.
According to its latest quarterly filing data, Yahoo's operations have hit a snag. Its latest reported quarter, ending September 30, 2008, yielded the company about $54 million in profit, which is a sharp decline from its three previous quarters, which saw the company take profits of $205.72 million, $542.16 million, and $131.22 million, respectively.
That said, Yahoo has been able to increase its cash reserves. According to third-quarter data, its total cash on hand increased by about $100 million over the previous quarter, to $2.14 billion. Considering Yahoo's 2007 Annual Report claims the company had $1.5 billion on hand by the end of 2007, and given its current cash growth, we can expect its coffers to have grown significantly year-over-year once it reports its fourth-quarter earnings later this month.
While Yahoo still enjoys a healthy, albeit declining, profit each quarter as well as ample cash reserves, it's trailing far behind its main competitor, Google. Based on Google's financial data, the online powerhouse enjoyed a $1.28 billion profit during the quarter ending September 30, 2008, and its total cash on hand has grown to more than $8.3 billion. That's a far superior position to Yahoo.
Balance sheet health: Outstanding
When it comes time to examine the value and growth potential of a company, its balance sheet can be a key indicator of whether or not you should invest money. With no long-term debt and billions in assets in its financial structure, Yahoo is in a good position.
According to its latest quarterly filing, Yahoo's assets--cash, investments, receivables, and property--are valued at $13.9 billion, while its liabilities are valued at just $2.3 billion. The balance can be found in the company's Stockholders' Equity section, which boasts more than $16 billion in retained earnings (the portion of the net income that is kept by Yahoo) as well as Additional Paid-in Capital (cash received from investors who are paying more than the par value for each share acquired). But Yahoo's balance sheet also includes $5 billion in Treasury Stock--stock that is repurchased by the company to reduce the number of outstanding shares on the market. That reduces the total amount of stockholders' equity, but it should be noted that it's the result of a repurchase performed in 2005.
Yahoo has no long-term debt, which is a major advantage for a company experiencing the kind of upheaval Yahoo is in the middle of, and the company has a healthy ratio of assets to liabilities. In other words, the balance sheet tells us there appears to be little need to worry Yahoo experiencing financial ruin anytime soon.
But competitor Google, once again, trumps Yahoo with $30 billion in assets and just $3.3 billion in liabilities. Google only has $13 billion in retained earnings and capital surplus, but it has yet to buy back any shares, so it has no Treasury Stock in its balance sheet. Much like Yahoo, Google is in an enviable position, but with more cash and more assets, it's in better shape than Yahoo.
EPS and P/E: Trouble in paradise
More often than not, companies are valued based on their earnings. Because of that, key calculations like earnings per share (EPS) and the price-to-earnings (P/E) ratio are used by most analysts to offer opinions on whether you should invest money in a particular company or not.
Earnings per share measures the amount of profit attributed to shares owned by investors. The higher the EPS, the more valuable a stock actually is. Based on its latest quarterly data for the period ending September 30, 2008, Yahoo's earnings per share was determined to be just $0.04. According to its 2007 Annual Report, Yahoo's EPS for the year ending December 31, 2007, was just $0.46. Worse, Yahoo's earnings per share has decreased by more than 50 percent year-over-year.
The price-to-earnings ratio is used by some analysts to determine the financial health of a stock. In essence, the P/E ratio determines whether a stock is fairly priced. Some analysts believe the P/E ratio should match the growth percentage of EPS, which, for Yahoo, is nonexistent, since its EPS decreased by 50 percent in just one year. Yahoo's trailing P/E ratio is 18.94, which suggests, based on its year-over-year EPS decline, the stock is slightly overvalued at its current price of $12.30 per share.
It can be shortsighted to use this comparison to determine value and financial health without considering market factors and key indicators like management effectiveness. But by these traditional metrics, even at one of its lowest points in the past year, Yahoo's stock price was still overvalued.
For comparison's sake, Google's EPS has grown more than 30 percent in the past year and its P/E ratio is 19.67. As Yahoo's footprint and value continues to shrink, Google picks up the pieces.
Management effectiveness: Hopefully improving
Last week, determining Yahoo's management effectiveness would have been simple. But now that it announced the appointment of Carol Bartz as its new CEO, we should keep in mind that the following management effectiveness calculations shouldn't be given too much weight in long-term estimates.
In order to determine management effectiveness, the investment community has developed two calculations: return on assets (ROA) and return on equity (ROE). In essence, ROA measures the company's profits attributed to assets, while ROE measures the company's profit attributed to its equity, or ownership interest. Yahoo's performance on both counts has been getting worse.
Yahoo's current return-on-assets ratio is just 0.82 percent, while its current return-on-equity ratio is 1.87 percent. That tells us that Yahoo earns just 0.82 percent profit on all the assets it owns, and it generates only 1.87 percent profit on every dollar invested by shareholders. Generally, and depending on the industry, a higher ROE means a company is more efficient. Yahoo isn't.
Yahoo compares very poorly to Google, whose latest financial data shows a return-on-assets ratio of 14.35 percent, and a return-on-equity ratio of 20.82 percent.
Market factors and forward-thinking considerations
Yahoo is facing all these troubles in a time when its future is very much in doubt. Each month, Google captures more search market share, and Google does much better in advertising than Yahoo, too. Its founder and CEO was forced to step down after rebuffing repeated attempts by Microsoft to acquire the company for a stock price premium that was then 62 percent, but is now more than 100 percent. And after two rounds of layoffs and a reorganization, nothing improved.
That doesn't mean Yahoo possesses no redeeming qualities. It's still a top online destination with billions of pageviews flowing into its properties each day. Its Yahoo Mail application is widely used throughout the world, and a series of smart acquisitions, like Flickr and Delicious, have given it leading products in important categories. And although its financial health is declining, a strong balance sheet, no long-term debt, and healthy cash reserves mean there's still time for CEO Carol Bartz and her management team to turn things around.
So what is Yahoo worth?
Yahoo's balance sheet may be strong, but its ability to turn a profit is declining each quarter, and competitors like Google have done a better job of monetizing their online properties, while gaining market share in the process. If we consider everything presented here, it's clear that the stock is currently overvalued.
When will Yahoo's stock be fairly valued? To offer a timeline would be foolish; there are simply too many macroeconomic and company-wide factors (like the new CEO) that play into such a prediction. But at this point, one thing is certain: Yahoo isn't a good buy.
Related: Google: Healthy and undervalued.
Don Reisinger's financial expertise and ability to evaluate public companies comes from his work, prior to becoming a journalist, as a public company auditor. He holds no positions in Yahoo.