Wall St Journal interactive says stock price should be cut in half, today. How low do you think the price will go?
Yahoo Inc.
Dow Jones Newswires -- September 11, 1998
SMARTMONEY ONLINE: Waiting For Yahoo! To Get
Cheaper
By Tiernan Ray
SmartMoney Interactive
NEW YORK (Dow Jones)--Is the party over for Internet stocks? We'd like to think so.
But just when it seems the insanely high valuations of these issues have come down to earth (or close
to it), their resiliency astounds us. As the Dow dropped 249.48 points Thursday, Yahoo! Inc.
(YHOO) closed down a mere 1/8 of a point. Excite Inc. (XCIT) actually gained 8.4% to close at 28
1/4 on news of a deal with on-line movie retailer Reel.com.
Only investors in Amazon.com Inc. (AMZN) seriously embraced the selling spirit, driving down
shares of the on-line bookseller 5, or 5.7%, to 79. But the selloff manifested itself only after a spate
of articles suddenly discovered that Amazon is in a notoriously low-margin business and has scant
hope of turning a profit until well into the next millenium.
The absence of earnings may be one reason to avoid Internet stocks, but it isn't the right one.
Amazon and Yahoo are both well-managed companies with promising futures, and may well turn out
to be the next Microsoft Corp. (MSFT) or Dell Computer Corp. (DELL) - in other words, the next
great tech stocks. The real trouble is, despite the recent fall from their Everest-like highs (Yahoo is
down 23% from its July 21 high of 103, Amazon down 46% from its high of 147 on that date), these
stocks are still too expensive.
In fact, their prices are out of all proportion with the great tech stocks everyone wishes they had bet
on years ago but didn't. As our chart above shows, Microsoft and Dell, for example, have classically
traded at P/E's of roughly 32 and 27 times trailing earnings, respectively, according to SmartMoney's
own research. Back in 1986, when Microsoft went public, a year in which observers ranted about
speculative excess and unreasonable premiums, the company's stock was considered expensive. But
even then you could have bought in at less than double the P/E of the S&P 500, which has averaged
18.9 over the past 12 years. Dell was even cheaper.
They were expensive, yes, but they received nothing like the premium Yahoo! has enjoyed: At
Thursday's close of 79, Yahoo trades at a multiple of 247 times this year's projected earnings of 32
cents a share, a pretty hefty premium to the company's projected earnings growth rate of 50% per
year, whatever financial model you're using.
Some of the other Internet valuations are equally ridiculous. Should you really be paying 75 times
Lycos Inc.'s (LCOS) expected year 2000 profit of 33 cents a share? At Friday's price of 25 and
with losses last year of 12 cents, you're paying a lot for what you might get out of Lycos's two years
down the road. With a loss of 23 cents a share expected this year, Excite's multiple of 68 times next
year's projected earnings of 38 cents a share is cheaper, but it's still rather gross.
There are plenty of reasons stocks enjoy a premium. Inflation is at a 35-year low, and consequently,
all stocks have enjoyed some premium in the last year. Microsoft and Dell have been trading at 50
and 33 times trailing earnings in the past 12 months, higher than their historical average, in other
words.
Some Wall Street analysts will of course tell you the Internet stocks are not enjoying a premium, or
not much of one, anyway. To present the case that stocks with little or no profits are cheap, they
have constructed detailed models of what earnings might be several years out, and they argue that
present valuation reflects a generous discount on the price of those future earnings. But all that is
really a justification for speculation.
The real reason for the premium is more closely tied to the way the shares trade versus the way other
stocks trade. According to CDA/Spectrum, about a third of Yahoo!'s 46 million shares outstanding is
in the hands of institutions. In the case of Amazon, 23% is held by institutions. It's a very small
amount of institutional ownership, relatively speaking, leaving a lot of shares in the hands of founders
like Yahoo!'s Jerry Yang and David Filo, and Amazon's Jeff Bezos. What Bezos and Yang and Fil o
don't trade is fought over in the retail market. Roger McNamee, a general partner with investment
firm Integral Capital Partners, echoed the fears of most cautious retail investors during his turn on
CNBC Thursday, when he referred to the 'uncertainty" resulting from all those retail investors fighting
over the crumbs Yahoo!'s founders drop from the table.
And here supply and demand play a large role. Individual investors in love with Internet stocks realize
that not only are there few shares to go around, but there are very few so-called "pure play" Internet
stocks to invest in, such as Yahoo! and Amazon. That affects supply and demand, too.
It's pretty clear, though, that the party is going to end sooner rather than later. The supply of Internet
stocks is not going to drop off drastically. Though the current economic mood has put a damper on
the market for public offerings, there's still billions in venture capital money pouring into the market for
Internet startups. Many of those companies may not go public, but many others will. In time, the
flood of new opportunities will be a tsunami sweeping over the Internet leaders, tarnishing their luster
as investors" love affair with the entire sector dims.
We have little doubt that the best of these companies, Yahoo! among them, will be able to rise above
this onslaught. Those like Yahoo! that have staked out their claims early in cyberspace will reap the
rewards of the Net's exponential growth - and will likely play a major role in shaping the Net's
development over the next several years. Jupiter Communications, a New York-based market
research firm that tallies numbers on Internet trends, says that dollars spent in online shopping by U.S.
consumers alone should reach about $37 billion by the year 2002 - a drop in the bucket in a $30
trillion economy, but nonetheless proof that a substantial amount of consumer shopping will take
place in cyberspace over the next few years.
That's not even counting auto sales or plane tickets, increasingly popular online purchase items.
It is, perhaps, that awesome promise that has seduced many investors into paying amazing prices for
Internet stocks. Or maybe it's just speculative greed. You can't stop speculation, of course. These
days it's a natural expression of a robust economy and higher consumer confidence.
Many retail investors who might go out to a movie or splurge on expensive vacations are instead
logging onto their online brokers to play the equivalent of Internet Lotto.
But with the challenges facing young companies like Yahoo!, the notion that supply and demand will
sustain these stocks' present valuations is more a sucker's bet than a gamble. Retail buyers know only
that there's a fifty-fifty chance the euphoria will continue, and a fifty-fifty chance these stocks will meet
the wild expectations held for them over the next three to five years.
The earnest technology investor, on the other hand, likes to have some fundamentals on his or her
side when gambling. If Yahoo! has the prospect of 50% secular growth for the next several years,
maybe a premium of double that growth rate is fair. That would give the company a forward PE of
100, or a price of less than half of what it's trading at now. Now that the party may finally be over,
we hope we'll see a buying opportunity like that in the near future.
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