I ran a 10-year discounted cash flow model on Yahoo's owner earnings (free cash flow). These are actual cash earnings that could be returned to shareholders versus reported GAAP earnings, which can be subject to all kinds of accounting tricks.
Even with the rosiest of assumptions, I put a fair value of $34.32 per share on Yahoo!'s stock.
Short of Yang just flat out not wanting to sell Yahoo!, by asking for a high buy price, how on Earth does he figure Yahoo! is worth at least $37.00 per share?!
I've run several models and I don't come anywhere NEAR $37.00 per share.
I even read at one point Yang may have wanted $40.00 per share, based on his belief that Yahoo! would grow sales 70% per year for the next three years.
Surely, he's smokin' crack, right?!
What value do you put on the stock?
That's completely ridiculous. I'll make it real simple-
there is no way a discounted cash flow equation can result in a net present value that is 90X present cash flow. That's the most preposterous thing I've heard in a while.
What earnings growth rate did you use?? 500% per year or something?
Take a look at Yahoo's earnimgs over the past 3 years. It's not growing. In fact, net profit was $1.7B in 2005. In '07, it was down to $650m.
The value of Yahoo would be around $15/share. However, since they have implemented the scorched earth policy, it's $10, at best.
I go into my discounted cash flow model here:
Also, you obviously don't have an appreciation for free cash flow, as you appear to have your eyes glued to the income statement.
Cold, hard CASH is the life blood of a company -- NOT reported GAAP earnings!
Dividends are paid out of free cash flow. Shares are bought back using free cash flow. Debt is paid using free cash flow. None of these things is accomplished with reported earnings.
A company can report strong and growing earnings, year in and year out until the cows come home. But if it isn't generating cash and free cash flow, it won't be in business for much longer.
Such companies catch investors off guard all the time, because they were so focused on the income statement, rather than the cash inflows and outflows.
Don't make the same mistake.
Yes, but just because a company wants something, doesn't mean they'll get it.
It's only a matter of time before Microsoft will get its meat-hooks into Yahoo! at an even LOWER price.
In my view, Yang has less than 12 months to prove everyone else wrong, or this will go down as the biggest blunder in market history.
AOL Time Warner will be Shirley Temple in comparison.
I agree, and I stated on Friday that 35 should get it done. Unfortunately, the only thing that came to press regarding Yahoos demand was 37. It is possible they discussed 35 at the table, but we will never know because all of the reports state that MSFT was offering 33 and YHOO was demanding 37.
Oops! Something else.
Fair values are different from target prices.
Fair value is what a stock is WORTH -- target price, what the market will be paying for the stock in the next year or two.
We value investors see price and value as not being the same thing. The former what you pay for something, the latter what something is worth.
Remember the run-up to the tech bubble, where companies had stock prices of $80, $90, $100 per share -- while generating NO free cash flow, only to go belly up?
That's the difference between price and value.
...oh, and to answer your question, if my numbers hold true, my fair value is what the stock is worth right NOW. This is what is meant by a discounted cash flow model.
One values the stock based on all the CASH (after all expenses) the company will generate as an on going concern, discounted back to the present.
So, yesterday, Yahoo!'s stock closed at $27.34 per share -- but each share is actually WORTH $34.32 per share. However, you want to buy at a discount to that fair value. In my case, a 40% discount. This large discount helps to prevent capital losses, if again, my numbers don't hold up.
First off, remember I'm valuing the company's stock on its owner earnings (a variation of free cash flow). In other words, all the cash the company will generate in the future, discounted back to a present value.
Sort of like valuing a bond, this valuation method was popularized by John Burr Williams.
O.K., I used analysts consensus estimates of 22.3% for earnings growth for the next 5 years. Then, diminishing growth rates ranging from 20% down to 3% from years 6-10.
After year 10, I used a terminal growth rate of 3%.
I know analysts can be overly optimistic with their earnings estimates, so I used a discount rate derived from the Capital Asset Pricing Model formula to take this into account.
This gave me a 10.1% discount rate.
As is commonly done, I used the latest fiscal year owner earnings of $606.55 million as my model starting point.
So, when all the numbers are crunched and if my numbers hold true, I calculate Yahoo! will generate $45.887 billion in owner earnings (free cash flow) discounted to the present. Or, considering the company's current number of outstanding shares, $34.32 per share.
This is how I arrived at my fair value for the stock.
However, as a value investor -- yes, value AND growth stocks can be undervalued -- I require a healthy margin of safety. In my case, I prefer 40 percent.
This means, Yahoo! isn't even a potential buy for me, until it is selling for at least $20.59 per share or lower. And even then, there would have to be a probability of a nice recovery for the company.
So, there you have it.