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The most recent Rule Maker Column had a recommendation for buying more Yahoo! with the $500 that they will invest this month. In the article was an attempt to justify the price of the stock as being reasonably valued. This simply amazes me.

The stock is trading right now at 200 3/4. Its earnings are .10. Its five year earnings forecast according to the Fool is 55.88%. Now I know that valuation can be a dirty word (especially when using the P/E) but a little multiplication shows that it is almost beyond comprehension to call Yahoo! anything but overvalued.

If we take the earnings of .10 and multiply by the expected earnings growth of 55.88%, we get the following

In one year: .1 * 1.5588 = .15588 (and so forth)
In two years: .242
In three years: .38
In four years: .59
In five years: .92

This means that at current analyst projections, Yahoo! would have earnings of 92 cents (or .92) in approximately five years. That also means that at its current price it would have a P/E of 218 in five years. Remember that PE of 218 would be if Yahoo! stayed exactly at the same price and increased its earnings by 55.88%. It seems almost ridiculous to justify this.

Now analysts are often wrong so instead of a 56% increase in earnings per year, I will boost the number up to 70% a year for the next five years.

In one year: .1 * 1.7 = .17 (and so forth)
In two years: .29
In three years: .49
In four years: .84
In five years: 1.41

Therefore, if the percentage earnings increase for the next five years is 25% higher than the analyst forecast in five years the PE of Yahoo! would still be an incredible 142 if the price stayed exactly the same for the next five years. This would still be twice the annual percentage earnings increase. And of course it would be assuming that at that size Yahoo! could continue to increase its earnings at that pace.

The magazine writers and analysts and all sorts of other people that are regularly criticized at the Fool have come up with amazingly inventive methods for valuation that somehow make these stocks seem fairly valued. But looking at a simple PE in five years makes it obvious that Yahoo! is not only overvalued but incredibly so.

To know that the stock of choice is going to have a PE of 142 in five years if it grows at an annual rate 25% higher than estimates even if it stays at the same price, and knowing that the 70% growth rate is going to be rather difficult to keep up (even if they can attain it for five years), makes it a little difficult for me to fathom how one could justify buying more.

Yahoo! is tremendously overvalued. There just isn't a way around that.

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