Is Yahoo! Inc. Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Yahoo! fit the bill? Let's look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Yahoo!'s story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's look at Yahoo!'s key statistics:


YHOO Total Return Price Chart

YHOO Total Return Price data by YCharts

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

(26%)

Fail

Improving profit margin

49.9%

Pass

Free cash flow growth > Net income growth

69.3% vs. 10.9%

Pass

Improving EPS

40.9%

Pass

Stock growth (+ 15%) < EPS growth

115.8% vs. 40.9%

Fail

Source: YCharts.
*Period begins at end of Q4 2010.

YHOO Return on Equity (TTM) Chart

YHOO Return on Equity (TTM) data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving return on equity

0.5%

Pass

Declining debt to equity

Debt raised

Fail

Source: YCharts.
*Period begins at end of Q4 2010.

How we got here and where we're going
Yahoo!'s score hasn't changed from last year, as it earned the same four out of seven possible passing grades it picked up in its previous assessment. The company's revenue continues to erode, and when coupled with decelerating revenue growth from its stake in Chinese e-commerce giant Alibaba, things are beginning to look a bit grim. However, Yahoo! shareholders have enjoyed strong growth over the past couple of years, and the stock has hit peaks not seen since before the financial crisis. Is this rebound sustainable, or will the flaws in Yahoo!'s business ultimately doom its hopes of long-term survival? Let's dig a little deeper to find out.

Yahoo! recently posted market-topping revenue and earnings per share in its fourth quarter, despite losing digital ad share to fellow online giants Google and Facebook over the past few years. Yahoo! also offered promising revenue guidance for the first quarter, which is a rare bright spot for a company that's long been written off as less than the sum of its parts. Fool contributor Adrian Campos points out that Yahoo! has been preparing for a comeback in search engines, perhaps challenging Google's dominance -- it currently holds over two-thirds of the search market. Yahoo! may have plans to build its own search engine, but in the meantime it continues to leverage a long-term search and advertising partnership with Microsoft and its Bing search engine.

According to tech columnist Kara Swisher, Yahoo! might try to develop a mobile-oriented search engine to compete with Google News for ad revenue by providing a hassle-free ad experience. Yahoo! CEO Marissa Mayer has noted that smartphone usage jumped by 27% year over year in 2013, and approximately 3.8 billion Internet-connected devices are expected to be online by 2017. It's easy to talk about developing a new search engine, but history has shown how extraordinarily hard it can be to dislodge an entrenched search leader -- Microsoft has thrown billions into Bing (and lost billions in the process) without ever managing to significantly change the search landscape to Google's detriment. The number of paid clicks, the price per click, and the price per ad sold on Yahoo!'s search platform has also been in decline over the last few quarters.

Meanwhile, AOL's Adap.tv could pose serious threats to Yahoo!'s video-advertising revenue, even though this ad segment is projected to grow from $4.1 billion in global sales in 2013 to $9.2 billion in 2017. Marissa Mayer also plans to restrict ccess to popular services such as Fantasy Sports and Flickr to Yahoo! logins only, which will block millions who now use either Facebook or Google accounts. The walled-garden approach may boost engagement in the short run, but it poses a greater risk of attrition to similar services should Facebook develop its own (both Google and Facebook already have free photo-hosting services).

Fool contributor Brian Nichols notes that Yahoo! will be one of the biggest beneficiaries from Alibaba's highly anticipated IPO. Yahoo! owns approximately 24% of Alibaba -- China's equivalent to a combination of Amazon.com and eBay -- which has an estimated market cap of $150 billion, or about four times the size of Yahoo! itself. According to Bloomberg, Yahoo! will sell off some of its Alibaba stake, which could be worth as much as $37 billion.

Putting the pieces together
Today, Yahoo! has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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The article Is Yahoo! Inc. Destined for Greatness? originally appeared on Fool.com.

Alex Planes has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, eBay, Facebook, Google (A and C shares), and Yahoo! and owns shares of Amazon.com, eBay, Facebook, Google (A and C shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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