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TORONTO (GlobeinvestorGOLD)—So you're fresh out of university or college, and you want to invest a bit of money in something. Unless you got married while you were in school, or had several children, or are taking care of your invalid parents, now is not the time to invest in government bonds. Save that for when you get older. Now is the time to throw caution to the wind and invest in high-risk—but potentially high-reward—stocks.
And what better place to find that kind of stock than the technology sector? After all, it has some of the riskiest stocks there are, except perhaps for biotech (which is kind of an offshoot of technology anyway). But which to choose? What follows is just one example: a very large and well-known company that also involves a significant amount of risk. In a way, it sums up many of the risks that adhere to tech stocks.
This large and well-known company is the Internet-based "portal" site Yahoo! Inc. When it comes to Internet stocks, Yahoo is among the biggest there is, next to eBay Inc. and Amazon.com Inc. Started by college roommates David Filo and Jerry Yang in the mid-1990s as a simple directory list of popular websites, Yahoo has become a true Internet and e-commerce powerhouse, with revenue of almost $1-billion (U.S.) and 200 million users.
Not only that, but Yahoo actually makes money, one of the few true Internet companies to do so, and not through accounting tricks or other sleight of hand, but actual income on operations. Admittedly, it hasn't made a lot in the past 12 months—$172-million—but it is making money and has very little debt ($750-million), and $1.6-billion in cash.
So what's so risky about investing in Yahoo? It's a massive player with a commanding presence on-line, and a host of partnerships with other major media companies, and it's profitable. The one thing that makes Yahoo so risky is its stock price. But it's a doozy: in fact, it's probably one of the riskiest large-company stocks in the world when it comes to standard valuation benchmarks (although eBay comes close).
As an example, even high-growth companies are seen as getting close to over-valued if their stock price is more than 25 times their profit per share (although different investors have different benchmarks). Yahoo's stock price is 130 times its profit per share for the past 12 months, and more than 75 times the consensus forecast for the next 12 months by a group of brokerage firm analysts who follow the company.
In a similar way, even fast-growing companies who dominate their industry are seen as expensive if their stock is more than about 5 times their revenue or sales per share. Yahoo trades at more than 20 times its revenue. If you look at the company's "enterprise value," which is defined as its market value minus its liabilities, Yahoo's enterprise value is almost 100 times the company's operating cash flow—the money that comes in from its business after all its expenses have been taken care of.
So much for the risk. Where's the opportunity to justify that risk? Some analysts believe that Yahoo has a dominant brand identity when it comes to a range of Internet businesses—through its website but also its e-mail service, its discussion groups, its calendar software and so on—and that it will be able to extend this brand into new and even more profitable businesses, to the point where it could compete strongly against America Online, the pioneer of the on-line portal business.
Yahoo also bought paid-search company Overture earlier this year, which gives it a commanding position in one of the fastest-growing segments of the on-line world: providing advertising based on the search terms that users type into a website. According to U.S. Bancorp Piper Jaffray, the Overture deal "positions Yahoo to again become the leader" in the search business, its original focus. Thomas Weisel Partners said in a report that "content and networks win on the web, and Yahoo has them both."
And while the valuation multiples are sky-high, Yahoo's growth has also been rapid. Its revenue grew in the past 12 months by more than 32 per cent over the previous period, and its net profit grew 146 per cent—levels that some feel justify the high price of the stock. If Yahoo can't keep those numbers climbing at the same rate, however, the market could easily turn sour on the stock price, just as it did when the Internet bubble burst in 2000. That's what makes it a risky bet.
At the same time, however, Yahoo's growing presence in a wide range of on-line segments—from entertainment to business, from advertising to search—gives it the potential to become substantially larger as the Internet becomes an integral part of life as we know it. And that's the potential payoff that might make it a worthwhile bet to take.
Mathew Ingram joined The Globe and Mail's online news team in June of 2000, after spending four years as the Western business columnist, based in Calgary.