This article is part of our "Best Stocks for 2011" series where our Foolish writers pick their top stock ideas for the year ahead. Click here to see a review of last year's picks and our 12 recommendations for the year ahead.
Picking stocks during the past two years has been a pretty fun game akin to throwing darts at your local watering hole. While there have certainly been plenty of bull's eyes, for the most part just hitting the board was guaranteed points.
Since the beginning of 2009, the S&P has advanced by almost 40%, while the Nasdaq is up nearly 70%. In fact, just last Wednesday the Nasdaq-100 came within pennies of its October 2007 peak before the market began its financial crisis meltdown. Was this a coincidence? I think not, but I'll leave the talk of double tops and market reversals to the technical analysts.
So what does this have to do with my stock pick of the year? Well, for one I believe much, if not all, of the recovery has been baked into the stock market over the past two years. The returns have been staggering to say the least, but in 2011 I'm ready to step up my guard and play a little defense. That means becoming a more selective stock picker and looking for companies that have a large margin of safety just in case the market does roll over.
With that in mind, my top stock idea for 2011 is a company whose CEO says, "When you get 30 miles outside of Silicon Valley and New York, it has a great reputation." Well, Carol Bartz, our CAPS community isn't too high on your company either, but I see a ton of value in Yahoo! (Nasdaq: YHOO ) .
It's certainly been a tumultuous couple of years for Bartz as the leader of Yahoo!. It is a company that Bartz herself has had difficulty understanding, let alone explaining to investors. Recently, she was asked to do just that, to which she replied, "Maybe it's taken me two years, but I've got it: content, communications, media, and innovation. I think Yahoo! has always stood for those words. It went off track a bit when people thought it was a search company."
While Bartz may not grasp exactly what the company's focus should be, she does acknowledge that it should be geared more toward Facebook than Google (Nasdaq: GOOG ) . With Yahoo!'s search business now in the hands of Microsoft (Nasdaq: MSFT ) , it can now focus on some of its high value and social assets.
Yahoo! is actually the leader by a wide margin in a social network that has been around long before Facebook. Yahoo!'s fantasy sports games bring more than 30 million unique users to the site monthly, and not just any users: The majority are from the highly coveted age 25-49 male demographic. This had made Yahoo! Sports the most visited sports site on the Internet, commanding 20% of all time spent surfing online sports properties.
The company's continuous improvement of Yahoo! Sports is a stark contrast to what many believe are the company's two crown jewels: Yahoo! Finance and Flickr. While both sites are widely used, Yahoo! hasn't really added any value to either for years. Yahoo! Finance had 17 times as much traffic as Google's comparable finance site in 2009, but as Google continues to upgrade its content, Yahoo's has been close to stagnant for years.
Since being acquired in 2005, Flickr, which was once the largest photo sharing site on the Internet, was quickly overtaken by Facebook. While many are satisfied that Yahoo! didn't destroy the site, the company has certainly not added much value. These assets do remain valuable, but similar to the company as a whole just need some direction.
The real value
While I do think that the value in these assets will be unlocked at some point, it is not what excites me about the stock in the coming year. What does excite me are the initial public offerings of Chinese companies E-Commerce China Dangdang (NYSE: DANG ) and Yoku.com (NYSE: YOKU ) that show how undervalued Yahoo! is.
Both companies recently completed IPOs in the U.S. and have already achieved values of greater than $2 billion and $3.5 billion in market capitalization,respectively. Yoku is China's equivalent to YouTube, while Dangdang is an Internet retailer similar to Amazon.com (Nasdaq: AMZN ) . Dangdang is a much smaller competitor of China's largest e-commerce company and the eBay (Nasdaq: EBAY ) of China called Tabao. More importantly, Yahoo! owns 40% of Taobao's parent company, Alibaba. Many analysts had valued Yahoo's stake in Alibaba around $11 billion, but if these recent IPOs are any indication, those estimates woefully underestimate the price the market is willing to pay for a similar IPO or spin-off of Alibaba's top online shopping site, Taobao, which has more traffic and sells more merchandise than Amazon.
Yoku's stock price increased by 161% on the first day it traded on the NYSE, and it is still not even a profitable company -- but let's look at Taobao to Danddang because they are more easily comparable.
Dangdang's first year of profitability was 2009, in which it produced revenue of $218 million and profit of $2.5 million. Analysts estimate that Taobao earned a similar amount through advertising fees and enhanced product listing fees that it charges consumers. However, the profitability from these transactions is many times higher than what Dangdang earns from its total revenue.
In addition, through September of this year, Dangdang has reported that its site has had 1.61 million daily unique visitors compared with Taobao, which has reported more than 50 million daily unique visitors through October. This helps explain why analysts believe Taobao accounts for 75% of China's rapidly growing online commerce market, while Dangdang's site accounted for less than 1%.
Even Yahoo! can't screw this up
So a barely profitable Dangdang, which our own China guru Tim Hanson calls an also-ran, trades at more than 300 times EBITDA. If we apply a similar evaluation to Taobao -- the rapidly growing leader in the fastest-growing Internet market in the world, in which only about a third of the population is online today -- you begin to see just how much this company might be worth.
This doesn't even take into account Alibaba's other properties such as Alipay, which is China's equivalent to eBay's crown jewel, Paypal. Alipay recently overtook its U.S. counterpart as the largest online third-party payment platform in the world. Alibaba's other properties include the Craigslist of China, Koubei, and publicly traded Alibaba.com, which is the leader in e-commerce for Chinese exporters. The best part of all is that Yahoo! can't screw up a company it doesn't run, at least on its own.
With that being said, it is hard for me to come up with a valuation that doesn't have the total value of Yahoo!'s Alibaba stake worth more than the company's entire $22 billion market capitalization.
I won't attempt to argue that Bartz can lead a Yahoo! turnaround, or that the company is on the verge of tremendous growth. However, I do believe that the company is woefully undervalued and under pressure to unlock some of this value soon. In addition to some of its core assets I discussed and the ownership in Alibaba, Yahoo! also has a 34.5% stake in Yahoo! Japan believed to be worth at least $7 billion, as well as an additional $2.8 billion, or $2.16 per share, of cash on its balance sheet.
Even without a Taobao IPO, if Yahoo! were to sell some of its foreign assets and raise a significant amount of cash, the idea of Bartz taking the company private isn't out of the realm of possibility. Many commentators also believe that Microsoft might be looking to make another offer for Yahoo!, but I think eBay is a better match as the company looks to boost its e-commerce marketplace.
For Yahoo! and its investors, I believe 2011 will be less about the whole and more about extremely undervalued parts.
Which is the best stock for 2011? See all 12 candidates here.