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Yahoo! Q3 2002 Results

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By DeliLama
October 10, 2002

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I've been following Yahoo over the years from a very safe distance. My primary method of valuing this company is in two steps. Remember always that it's better to be roughly right than precisely wrong, as Buffett always says. It's better to have a highly confident, but very rough lower bound on something far into the future than to have an exact estimate that's based on too many assumptions. Always know your assumptions! I believe that to do this kind of analysis, you need to routinely go back and look at things you had predicted in the past to see how precise and accurate you can realistically be (and also to correct for the unavoidable biases).

Step 1: What will Yahoo most likely look like as a business in about 10 years, assuming that they thrive that long? I use the term "thrive" rather than survive because a company that is barely surviving will not be able to take advantage of opportunity and will not remain competitive.

My thinking here is to start with the number of people who watch television. Over time, a certain percentage of these people will spend a certain amount of time online instead of in front of the TV. Online activities will probably steal a certain percentage of people's time. It's unlikely that people overall will have more time, so you can view it as a zero sum game. Keeping in mind that television based businesses are not going to be standing still while online activities eat their lunch, it's probably good to figure out what people's natural steady state percentages are between online activities and TV activities. I believe that it's safe to assume that the leading TV businesses are likely to continue to adapt TV in the best manner possible to counteract online businesses. And those online businesses are likely to do the same.

I've observed over the years that online activities are fundamentally different from TV. Something that works on TV, doesn't seem to work well on the computer and vice versa. I believe it's something ingrained in our nature that may go back to prehistoric times. TV tends to simulate passive observation of group activities (it's the theater). People seem to be wired to spend time in this mode. Online activities tend to simulate interactive individualized activities either alone (such as craft-like activities) or between a small number of people (it's like knitting, playing cards, or chatting with your neighbors).

So what are the percentages of time allocated to TV vs. online stuff? I don't know. To be safe, we should assume that reading activities (books, newspapers, etc.) will also struggle to keep their 'market share'. So I'd be very conservative in estimating the total eyeball time that the online world gets.

There's a general rule of marketing that says that whoever is first in the minds of the customer generally end up staying in first place in the market. If you look at various types of markets, generally whatever product is the leading product was also the first in the mind of the customers: Coca Cola soft drinks, Gillette razor blades, Wriggly chewing gum, etc. Back in 1996, I believed that Yahoo was in that same role. They still are and I believe it's likely that they will remain so. But it's never a sure thing.

So the question now becomes a matter of estimating a reasonable lower bound on the total market size for online activities (whatever they may end up being) and then separately figuring what percentage of that total market will belong to Yahoo. You'll notice that I break apart the problem into smaller pieces. I believe this is very important for complex problems like this. And rather than trying to use exact numbers (haha!), it's much better to search for very rough reasonable lower bounds.

Step 2: What are the odds that Yahoo will thrive during the entire time between now and 10 years from now?

For this part of the problem, you want to look at the details of Yahoo's business, their balance sheet, and their "burn rate" (I wouldn't automatically assume they're free cash flow positive forever going forward). Once again, I usually break this kind of problem down into individual pieces, look at each piece, and then assemble them back into an overall answer. To do that here, I would spell out all the possible scenarios that might happen in the next 10 years, both in the overall economy and for what happens to Yahoo. This is one situation where studying business history helps out a great deal. You know the things that can go wrong.

In coming up with these, I tend to view the corporate culture as a very real and long lived intrinsic part of the business. Microsoft is fast, strategically clever, and sloppy. Intel is nowhere near as strategically clever, they aren't as sloppy. Some companies are just fricken stupid. Some (very, very few) are totally focused on winning. I believe these traits will remain in place far into the future. Yahoo is pretty good at absorbing new stuff into the business, but they aren't extremely strategically clever. They understand their customer reasonably well. Etc.

So I would come up with all these scenarios and then rule out the ones which are silly or implausible. The remaining scenarios, I would roughly figure out the odds of each one happening in order to get a gut feel sense for what the businesses future looks like. I never look at this stuff as a single number, but rather a range of numbers and probabilities of their likelihood.


At the end of all this breaking the problem into pieces, analyzing each piece, and putting them back together, you should get a sense for the overall result such as, "I'm fairly sure they'll be fine, but there's a very real chance that they won't." If everything looks good (the chances of success being high and the present value of the payout on success being high), I'll invest. If I believe the likelihood of success if extremely high or the downside is very limited, I'll invest more.

I believe it's extremely important to assess both of these steps independently because they are independent. In order to win the race, you must finish the race.


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