Jim: Well, Mike, we're back to one of our favorite topics, Internet stocks, and there's no bigger name in the business than Yahoo. In fact, you could say it's the market's Internet bellwether now.
Mike: I suppose so. But to me, Yahoo is the quintessential situation in which you can love the company and hate the stock.
Jim: Then you'll probably be surprised that I like this stock.
Mike: No! Are you telling me that you actually like a stock that has a price-to-earnings multiple of 770? I never thought I'd see the day.
Jim: I'll give you a moment to catch your breath. Look, our readers well know that we're not big on Internet stocks generally, because they trade at outlandish prices relative to the fundamentals of their business.
Mike: Relative to rationality is more like it.
Jim: But I think Yahoo stands apart. The company, of course, is probably the best-known multifaceted "portal" from which to search the Internet.
Mike: It's more than a search engine.
Jim: Exactly. It also has, among other things, a major linkage to electronic commerce. You can go through Yahoo to reach something like 7,000 merchants.
Mike: In fact, I would say Yahoo is the only real example of what Web followers like to say is the first-mover advantage. It was first and it took off. People talk about Amazon.com being the first-mover in online book sales, but, of course it hasn't made a dime of profit yet.
Jim: But Yahoo is making modest profit.
Mike: Very modest. I like Yahoo, Jim, and I think it's run by a lot of smart people--and some of the least arrogant people in the business. The company will do quite well. But I keep going back to that P/E multiple of 770, and I say it's ludicrous to even think about buying this stock at current levels.
Jim: Now just stop for a second.
Mike: I was in mid-stride!
Jim: You were delivering a soliloquy. It's clear that a lot of people agree with you. Over the last 12 months, this stock has again tripled in price ...
Mike: But over the last few months ...
Jim: Right, it's gone nowhere. It's actually down about 4% since late March, which is about when all Internet stocks started to stumble, and now trades around $170.
Mike: So for several months this wonderful outfit hasn't made its investors a dime. We've said this before, and we often get taken to the woodshed for saying it, but the proponents of Internet stock valuations are blowing smoke. Yahoo is a classic example.
Jim: Thanks a lot.
Mike: I'm talking about the parade of Wall Street analysts who claim to see nothing outlandish in this stock's valuation. In fact, they call it a virtue that the stock is priced in the ionosphere. As I said, you can love the company and believe it's going to keep growing, and still not see any reason to buy the stock at this level.
Jim: Well, I'm going to suggest buying it as a long-term, albeit speculative, play on the growth of the Internet, even at this price.
Mike: Speculative, meaning you're likely to lose all your money.
Jim: No, speculative meaning you're not buying General Electric. Of course Yahoo will be an extremely volatile stock, Mike. But over the long run, it will remain a leader in this incredibly fast-growing industry. And at least it makes a profit.
Mike: Profit with a small "p."
Jim: Granted. But its revenue is also growing nicely. It has good management, as you said. It's also the best-known brand name on the Internet.
Mike: Need I remind you that brand names are not everything? If they were, we'd all be staying at Howard Johnson every time we travel.
Jim: Fine, but it still counts for a lot in the wildness of the Internet, and Yahoo has a great head start in being a brand almost synonymous with the Net.
Mike: And when you're trading at 700 times earnings and you make any mistakes, get ready to see your stock drop a couple of miles.
Jim: By the way, that P/E you mentioned is misleading because you're looking at last year's earnings. It's trading for only about 350 to 380 times this year's expected earnings per share, in the range of 40 to 50 cents.
Mike: Oh, I'll sleep a lot better.
Jim: You know we have no argument about the wild price. I mean, the revenue of Yahoo for the nine months ended Sept. 30 was $388 million, and you know what its total stock market value is now? It's $44 billion.
Mike: Right, and so are we to take it on faith that other investors will continue paying even higher prices for those kinds of sales and earnings, so you could ever sell your Yahoo stock for a profit?
Jim: You're referring to the "greater fool" theory of investing, of course.
Mike: And you'll never find me saying there aren't a lot of fools out there. I'd just prefer not to join them.
Hughes Electronics (GMH)
Mike: Hughes Electronics is majority-owned by General Motors, but it has its own stock. And Hughes made its reputation in the fields of electronics and space, but guess what? It's really a television company.
Jim: Yeah, Hughes was one of the first so-called tracking stocks, when GM created it in 1985.