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'Preciate it. Moving on...
In my estimation, one of the biggest keys to investment success is the ability to think independently. It's easy to jump on the latest bandwagon, follow the latest trend, or take a stake in a hot company, industry, or mutual fund. One of my favorite recent examples of independent thinking came from Warren Buffett when he commented that, if you're in the stage of your investment career where you're adding money to the market, you should actually be happy to see stock prices decline.
A truly Foolish investment portfolio is characterized by the following traits:
- It includes shares of solid companies that you've researched and know well;
- It only includes money you don't expect to touch for at least 5-10 years; and
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Your focus on investing is long-term rather than short-term.
If your portfolio has those characteristics, then the market's performance over the last 9-10 months shouldn't be all that troubling to you. If your portfolio doesn't have those characteristics, then it's quite possible that either you've suffered from poor performance and/or the market's gyrations have caused you a lot of heartburn.
Independent thinking is a characteristic that I believe is shared by successful companies and successful investors. In December, I wrote a column discussing why the current market and economic conditions could be presenting companies like Intel (Nasdaq: INTC) and Cisco Systems (Nasdaq: CSCO) with opportunities that would allow them to extend their run of success into the future.
The basic premise of my argument was that, when times are toughest, the strongest companies have the resources to create future opportunity. They can do that by seizing greater market share, continuing to invest in the future through research and development activities, or acquiring companies that have great ideas but don't have the financial wherewithal to stand on their own.
Making these types of investments when others are fighting for survival is something that successful management teams are able to do. It's also an example of independent thinking.
After reading Yahoo!'s (Nasdaq: YHOO) latest earnings report, I'm left wondering if Yahoo! is another company that can use its financial strength to seize future market share and better position itself for the future. Yahoo!, battered as it is with a stock that's down 88% off its all-time high, is still in good fighting shape compared to most other dot-coms, which are literally on the verge of collapse.
As discussed more fully in a Forbes article, Yahoo!'s approach to advertising has given it a clear edge on its competitors. The information that Yahoo! is able to provide to its clients about its customers is far better than that which can be gathered from virtually any other Web-based company.
In its fourth-quarter earnings press release, Yahoo! clearly stated that it intends to use its strong financial and market position to capture even more market share over the next year. With $1.7 billion in cash on its balance sheet and not a cent of debt, Yahoo! has a solid war chest it can use to fund this initiative.
As a Yahoo! shareholder, this approach to managing a business is just what I want to hear. But, there's a little more to the story than that. Although we state in our Rule Maker Steps that business quality is at least 100 times more important than valuation, that doesn't mean that we avoid valuation altogether.
It's actually the issue of valuation that led us to add the Cash King Margin to our Rule Maker metrics. Whenever I try to value companies, I always perform some type of discounted cash flow valuation aimed at determining what type of growth in free cash flow has been priced into a company's stock.
The one thing that troubles me about Yahoo! right now is that I see its ability to grow free cash flow at the levels we've become accustomed to being dramatically curtailed. Since Yahoo! was gracious enough to be the first company that I follow to include a cash flow statement with its earnings release, we can take a look at what's given me pause for concern. Three issues stand out.
First, Yahoo! stated in its earnings release that it expects its days sales outstanding (DSO) to increase to the 30-to-50-day range, up from a DSO of less than 30 days for the last 10 quarters. Yahoo!'s clientele is transitioning from mostly dot-coms to mostly blue chips. The blue-chip Fortune 500 clients are demanding longer payment terms, and thus Yahoo!'s accounts receivable and DSO will increase. The upshot? Higher accounts receivable reduces operating cash flow.
Second, approximately one-third of Yahoo!'s operating cash flow over the last 12 months was a result of the tax benefits the company received because its employees exercised stock options -- which, as discussed in our article "Stock Options Can Skew Cash Flow," is not a reliable source of cash flow.
The third factor affecting Yahoo!'s cash flow that gives me pause for concern is the decline in deferred revenues, which are now back to their balance at the end of the first quarter. Deferred revenues represent cash that a company has received from its customers in advance of delivering all the services related to such revenues. This is related to concern #1: Yahoo! is no longer receiving up-front cash payments for its services because of its changing client mix. While it's certainly a good thing that Yahoo! is gaining Fortune 500 clients, the cost of financing those customers who aren't willing to pay up-front will cause a short-term reduction in operating cash flow.
These factors have resulted in Yahoo!'s Cash King Margin declining to 16% in the fourth quarter. Like Cisco, which has also seen its operating cash flow growth slow over the last year, changes are occurring in Yahoo!'s operating environment. As it increasingly turns to "Old Economy" companies for business, it's finding that it doesn't always have the hammer in its business dealings. It can't collect from customers as quickly as it did in the past. This causes its cash flow growth to decline.
Does this mean that I think Yahoo! won't be successful over the long haul? No. I think it has a high-quality management team that will drive it towards future success. But, I don't believe that it will be able to deliver the rate of free cash flow growth that I'd previously anticipated. That means it will have less cash to invest in its future growth, too.
Taking stock of our businesses by focusing on metrics other than earnings per share and revenue growth is the kind of thinking that we need to do if we want to be successful investors over the long haul.
Have a great day.
Phil Weiss, TMF Grape on the Discussion Boards and rooting hard for the Giants on Super Bowl Sunday
