We closed this position on August 5, 2011. A copy of the associated Position Update report is here.

Yahoo is one of August’s Most Dangerous Stocks. Free copy of report: YHOO. And like all of our Most Dangerous Stocks the company has:

1. Misleading earnings = accounting profits are positive and rising while true, economic profits are negative and falling
2. High Valuation = very high expectations embedded in the current valuation.

Red Flags:

1. YHOO reported a $173mm increases in GAAP earnings** while our model shows economic earnings declined by $267mm
2. The company’s ROIC is in the Bottom Quintile of all the companies we cover.
3. Stock price of $14.00 implies YHOO will grow its NOPAT at 15% compounded annually for 20 years. A 20-year Growth Appreciation Period with 15% compounding growth rate is quite a high standard to beat, as per my post on How To Make Money Picking Stocks.
   

Overall, the Risk/Reward of investing in Yahoo’s stock looks Very Dangerous to me. There is lots of downside risk given the Misleading Earnings and there is little upside reward given the already-rich expectations embedded in the stock price.

As per Investment Strategy 101 and How to make money picking stocks, YHOO fits the profile of a great stock to buy.

**See Finance 101 for more detail on why accounting profits are not reliable indicators of corporate profitability or value creation.

Note: Stock pick of the week is updated every Tuesday.