1 Important Metric You May Have Missed in Yahoo!’s Quarter

Don't celebrate Yahoo!'s earnings just yet, as you may have missed one important, and telling, metric.

Apr 21, 2014 at 1:30PM

Yahoo! (NASDAQ:YHOO) shares soared higher in after-hours trading when the company reported earnings, which met expectations and continued the company's trend of marginal growth. Yet, as usual, Yahoo! earnings are a back story, and the insane growth of Alibaba has taken center stage. However, in the midst of excitement, investors are missing one important fundamental metric, and it's this data that might make either AOL (NYSE:AOL) or Google (NASDAQ:GOOG) far better investments moving forward.

What impressed Wall Street?
In Yahoo!'s first quarter, it grew total revenue by less than 1%, but among the things that impressed Wall Street was the company's better-than-expected second-quarter guidance. Furthermore, the company saw its largest segment, display advertising, produce growth of 2% following a 6% and 7% decline in the last two quarters, respectively.

However, nothing about Yahoo!'s first-quarter fundamentals is driving the stock's current 7% gains. Instead, it's the 66% revenue and 110% net income growth of Chinese e-commerce giant Alibaba, which represented accelerated growth compared to the prior quarter.

This will likely be Yahoo!'s last report before Alibaba's IPO, which is valued at $150 billion, and could reach $200 billion. Hence, with Yahoo!'s stake of 24%, the company could earn up to $40 billion if its entire stake was sold. However, with current plans to sell 40% of its stake, Yahoo should generate $10 billion following Alibaba's IPO (this accounts for corporate tax). 

What will be left of Yahoo! post-Alibaba?
Eventually, Yahoo! will lose an important, fast-growing asset in Alibaba, but will gain enough cash to make substantial investments elsewhere. While investors celebrate the potential for a massive cash-position, not many have stopped to ask what will be left of Yahoo! following the divestment. The answer to this question is evident in Yahoo's first quarter, and might not paint such a bullish picture.

In the quarter, Yahoo's net income declined to $312 million from $390 million year-over-year. The company gave no real excuses – there were $10 million in charges from restructuring changes and reversals – as most investors understood that the company had been spending rapidly to improve its products and launch new services.

However, as it relates to profit, one metric rose -- earnings in equity interests -- which is a direct reflection of profits created from Alibaba, and to a lesser extent Yahoo Japan. In the first quarter of last year, Yahoo! earned $217.5 million from equity interests, but this year it rose nearly 40% to $301.4 million. Hence, equity interests accounted for nearly all of the company's profit.

Looking back to last year, equity interests accounted for more than half of Yahoo!'s $1.366 billion in net income. Yet today, as Yahoo! continues to spend and Alibaba grows larger, it now looks as though the equity is a larger piece of Yahoo!'s bottom line. For investors, this may not be a good sign for the future of Yahoo! minus Alibaba.

Looking back at the last two years, Yahoo! shares have risen 140% with hardly any revenue growth. New leadership has changed the design of many of the company's sites. However, Alibaba's growth has been the main culprit in pushing the stock higher.

Therefore, after removing the $10 billion in cash from Yahoo!'s market cap, following its 40% divestment, the result is a $27 billion value for Yahoo!'s existing business. This translates into more than 45 times last year's operating income, minus 40% of Yahoo!'s equity interest and rising costs. If Yahoo! continues to spend aggressively, its equity interest in Alibaba could be the entirety of its profit for this year. By selling a 40% stake in Alibaba, that interest will be less impressive in its quarterly results, and the weakness of Yahoo!'s existing business could come to question, as could its lack of revenue growth -- two things that have been overlooked thanks to the Alibaba excitement.

Furthermore, Yahoo! will eventually divest its holdings in Alibaba, and even if it profits are $25 billion after taxes, and Yahoo! has a remaining value of $12 billion, investors must wonder whether the company will be profitable. If not, 20 times last year's operating income (minus a full $25 billion divestment of Alibaba) looks like fair value, meaning there might be little upside looking ahead. Essentially, Yahoo! must spend its money wisely, acquiring assets that will contribute to its bottom line. Unfortunately, this is yet to be seen.  

Investors might find more value in Google or AOL
AOL is cheaper at 16 times expected earnings for 2014, and has double-digit growth. Also, in the ever-important video streaming and advertising business, AOL has shown real strength. In its last quarter, advertising sales rose 23% to $507 million. In comparison, Yahoo! is barely growing, and its advertising has lagged. Hence, AOL is likely a better opportunity.

Google trades at 28 times earnings, which is more expensive, but for this premium investors get a company with double-digit growth and a position in one of the most innovative technology companies of the last decade. In addition to strong advertising revenue, Google has a slew of new products and services in the works, like Google Glass, self-driving cars, and most importantly, Google Fiber, which could ultimately give Google a large presence in the telecom space. Additionally, following Google's split, the company now has non-voting shares that can be used for acquisitions, perhaps giving it more cash than Yahoo! will earn from Alibaba.

Final thoughts
With all things considered, it's hard to find value in Yahoo! after Alibaba, and Yahoo!'s peers look like better investments. After all, Yahoo! may earn a lot of cash, but spending that money wisely is the big question mark.

Therefore, with AOL being cheap with growth and Google successfully entering new industries, both operate with bright futures. However, by removing Alibaba from Yahoo!, not much is left. Until you see how the company spends its money, there might not be much upside left.

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Brian Nichols owns shares of Yahoo! and Yahoo!. The Motley Fool recommends Google-Class C Shares and Yahoo!. The Motley Fool owns shares of Google-Class C Shares. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

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That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.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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