Yahoo in the Stock Market: How One Penny Sparked A 13% Collapse On Wall Street

by Mark Skousen, Chairman, Investment U
Thursday, January 26, 2006: Issue #506

Last week, Internet giant Yahoo (Nasdaq: YHOO) reported record profits. Net income surged nearly 84% to $683 million, or 46 cents a share, from $372 million or 25 cents a share a year earlier.

But guess what? Yahoo shares fell an incredible 13% on the news because the company missed its earnings target by one penny, as determined by Wall Street analysts.

Yes, that’s right. A one-penny miss turned into a 13% collapse in the stock market for Yahoo.

But before you throw up your hands in disgust with the “irrational” stock market, let me explain a fundamental principle of investing The sooner you learn it, the better. It will make you a superior investor.

The Key To Understanding the “Irrational” Stock Market

What determines prices of stocks? Most investors think that prices are determined by the fundamentals of the company – sales, profit margins, market share, etc. And in the long run, they would be right.Finance professors have proven beyond a doubt that earnings per share do determine the value of stocks over a five- or 10-year period.

But such figures may not be helpful in the short run. Why? Because company fundamentals are historical. And stock prices are determined by the future, not the past.

The real question investors must always ask is: What is the outlook for a particular stock over the next few months or years? What is the outlook for sales and earnings?

Another example is Cardero Resources (AMEX: CDY), a developmental mining company with properties in Argentina, Mexico and Peru. So far, it has no revenues whatsoever and plenty of expenses (it lost $3 million last year), yet its market cap is $156 million and the stock is up 50% from last summer.

Why is the stock heading north? Because investors expect Cardero to produce tons of copper, gold and silver at a substantial profit in the next few years. (By the way, I mention Cardero Resources and Yahoo only as examples. I™m not recommending them as buying opportunities.)

Yahoo stock moved up in the market for the same reasononly this time, investors sold off because they don™t think the company can keep growing as fast as it did in the past.

My own view is that investors are wrong about Yahoo and made a mistake selling the stock. I believe it will give Google a run for its money. Based on price/earnings ratios, Goog is currently selling for almost three times as much as Yahoo. Goog is selling at 97 times earnings, compared to just 27 for Yahoo.

Take a look at their stock prices over the last year

Let’s keep an eye on these two stocks.

Good investing,

Mark

Today’s Investment U Crib Sheet

• In Investment U # 505, we looked at the Economic Freedom Index published by The Wall Street Journal and the Heritage Foundation. China’s status is “Mostly Unfree,” which was evident in the recent news that Google’s search engine launch in the People’s Republic is subject to government censorship. Head back to the last Investment U for the implications of suppressing economic freedom: The Index of Economic Freedom: Where There’s Freedom, There’s Money To Be Made Especially In This Fund.

• Buying Stock in Microsoft: A Debt-Free Company That Wall Street Doesn’t Appreciate… Yet
• Understanding Earnings Surprises: What to Look For & Their Meaning For Investors
• Buffalo Wild Wings (Nasdaq: BWLD): Stock of the Day

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