Yahoo! Run Can't Last

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It might seem crazy to argue that Yahoo!'s (YHOO) stock should fall after Tuesday's blowout 2004 earnings and fantastic 2005 forecast.

But despite all the giddiness coming from management, and no doubt from most of Wall Street, there are a number of very good reasons why Yahoo!'s stock should trade at least $10 lower.

There is no denying that 2004 was a superb year for Yahoo!. Its earnings and revenue growth show without a doubt that the company will be a dominant force in the Internet for the foreseeable future. Earnings per share in 2004 doubled to 36 cents (excluding a gain) from 18 cents in the previous year. Moreover, profitability improved: In 2004, operating income before depreciation, amortization of intangible assets and stock-compensation expense, or OIBDA, jumped to 39.7% of revenue from 32.4% in the previous year.

Yahoo! management forecast even stronger profitability in 2005. The midpoint of Yahoo!'s guidance for OIBDA is $1.44 billion, which would be equivalent to over 41% of revenue. The company was eager to persuade listeners on its call that Yahoo! stands to benefit massively as more and more money is spent on Internet advertising. With all that good news, it would seem wholly justified for Yahoo!'s stock to rise from current levels, even though it's up 56% over the past 12 months. The stock climbed 49 cents to $37.67 early Wednesday.

So why argue that Yahoo! should be trading $10 lower?

Look at Yahoo!'s valuation -- it's extortionate. Let's assume Yahoo! does make around 50 cents a share this year, as analysts claim. (Yahoo! conveniently doesn't provide an earnings per share forecast. A per-share forecast requires projecting the number of shares likely to be outstanding through the year, and the company most likely doesn't want to draw attention to the huge amounts of shares it issues to pay its employees.)

At 50 cents a share, Yahoo! is trading at a price-to-earnings ratio of 74 times. On 2004 earnings, the ratio is 100 times. These are stratospheric numbers. They imply absolute confidence among investors that Yahoo! can meet its earnings and revenue goals in 2005 -- and do so without reducing earnings quality.