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January 18, 2006

Taking My Lumps and Selling Yahoo

As outlined below, I bit the bullet and sold all client and personal holdings in Yahoo (YHOO) this morning. I don’t think the YHOO story is over but the purchase was designed as a trade and discipline and the analysis in this post means that at least for the short-term it was time to move on despite incurring a 12% loss.

It is hard to pull the trigger and close out a losing trade. It is equally tough to write a column about it. It is easy when things go well and the trade is working great. When things go badly and a trade turns into a money losing investment, it is difficult to gather your thoughts and conduct analysis that leads to admitting you were wrong. Here is my analysis of the YHOO trade….

It looks like I got burned on the purchase of Yahoo in mid-December. I was looking at YHOO for a trade to $45. Early last week, success was close as the shares were at $44. At the time I decided to hold through the earnings report expecting that a good earnings report would spur the stock higher in what I expected would be a bullish market environment.

The trade began to go awry last week when Merrill Lynch downgraded the shares and several previews of the quarter were cautious toward valuation. Next, the market turned lower. Finally, the quarterly earnings and guidance were less than expected.

So the question is what to do now? I think investors are concerned that YHOO is facing a decelerating growth rate. Clearly, the latest quarterly results, the guidance, and the commentary on the conference call suggest this is a possibility.

My takeaway is that management views 2006 as a transition year where investments in new markets, new services, employees, and acquisitions will slow the growth rate slightly. Additionally, management noted $120 million in lost revenue from one-time items that was described as "very profitable." It seems to me that analyst estimates should have picked up on most these issues. Therefore, the slight miss on the quarter and lower than expected guidance is clearly a disappointment.

Not to be overlooked, however, is that revenue growth is forecast at 28% in 2006 with margins holding up. CFO Sue Decker promised that growth would accelerate again in 2007 as the investments would begin to provide a return and the one-time drags on revenue would disappear. She discussed the upside in 2007 as a "very significant" opportunity.

So where does leave the stock? I think that depends on whether guidance proves conservative. Unfortunately, we won’t know that for at least another three months and the next big datapoint, quarterly earnings from Google (GOOG) could reinforce the read that YHOO's growth and competitive position is under pressure. Therefore, I suspect that for the next few weeks it will be tough for YHOO shares to mount a significant comeback. Thus, taking the loss and moving on is the best course of action. I suspect I'll want to re-enter YHOO as the year goes on, possibly sooner than I expect, and maybe even at a higher price than the sale, because the estimates will likely prove conservative which means the 2007 acceleration is real. However, YHOO was purchased as a trading position meaning the time horizon of the trade doesn’t provide the luxury, or the option, to wait.

Ultimately, the lesson from YHOO is that there is no margin for error when valuation and expectations are so high.

Posted by Steve Birenberg at January 18, 2006 09:33 AM in YHOO