The Numbers That Foresaw Yahoo!'s 'Stealth Rally'

 | Nov 30, 2012 | 11:00 AM EST
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I am enjoying stellar profits in a surprising name -- and this has inspired me, once again, to point out the utility of estimate revisions in finding your new buy ideas. CNBC pointed out recently that Yahoo! (YHOO) is in a "stealth" rally, having appreciated from $15.77 to $18.87 -- a 20% gain -- since late October. The rally is stealthy because no one pays much attention to Yahoo! anymore. They figure the company is a has-been in an Internet space dominated by Google (GOOG), Amazon (AMZN) and the like. While Yahoo! does have plenty of work to do, one cannot argue with the numbers, and the company's earnings prospects are getting better under new CEO Marissa Mayer.

Yahoo! popped onto my radar screen back in June. That's when my quantitative screens noted that the upward estimate revisions were strengthening, even as the valuation remained reasonable. The stock was trading at 16x the forward-four-quarter estimate for earnings per share, basically around a market multiple. For me, this was the catalyst in my decision to see whether Yahoo! had the potential to turn around its prospects.

Of course, there was no way to know at that time that a new CEO would be appointed later in the summer, but I concluded there was sufficient ability to improve profitability, and that it was worth the risk to buy the name. Oddly, positive surprises such as Marissa often occur in names that are washed out, which is what Yahoo! was this summer.

I took a position in mid-June. "Why are you telling us now?" you may be asking. I didn't think the idea was that compelling at the time, and it was one of about a dozen stocks I bought around then. Anyway, the point here is not Yahoo!, per se, but the power of estimate revisions to direct you toward the best ideas.

In any case, over the last few months the earnings trend has continually strengthened, and many new strategic moves at the company promise to sustain the trend. Take a look at how the stock price is tracking the estimate trend.

Yahoo! (YHOO) -- Price Vs. Next Four Quarters EPS Estimates
Source: FactSet

Looking for strong estimate trends is not the end of your process but, rather, the start. Nonetheless, if you want to catch fish, go where they are biting. Fast-rising EPS estimates, combined with a reasonable valuation (which indicate low expectations) are your best map to the fishing hole. Yahoo! is one case study, and as long as the EPS trend remains here, I will continue to own the stock.

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