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.

Yahoo: New Buy For Client Accounts

With cash building in client accounts as winning trades were being harvested, I have been looking for a new idea to add to portfolios. I've picked up the hunt for a new idea because I believe the recent resting period for the broader market averages will give way to one more move upwards in 2005. Consequently, I was looking for an idea that would enjoy near-term momentum as the possibility exists that the stock would be sold if it reached initial targets quickly. I finally settled on Yahoo (YHOO) and shares were purchased across most client accounts earlier this week.

The purchase of YHOO was motivated by several facts....

First, cash positions in many accounts were higher than I wanted. Second, I remain bullish for the short-term and still think the S&P 500 can add another 2-3% to this year's gains within the next several weeks. Third, YHOO has a good chart after consolidating its recent up move. Fourth, technology in general, and the internet in particular, are in their seasonally strongest period of the year. The bottom line is I went long YHOO because I am bullish and willing to play what I think will be renewed momentum in the stock over the next few weeks as the market makes another move higher.

Regarding seasonality, I read in Advertising Age that, according to Nielsen/NetRatings, visits to online retailers were up over 35% vs. last year for the week of December 4th. YHOO is not a retailer but this datapoint gives a sense of how internet traffic picks up in the holiday season. YHOO can monetize some of this traffic, at least that which makes its way to any Yahoo! site. Further, some of YHOO's regular users are likely to increase their searches at this time of year. So even if YHOO loses further search share to Google (GOOG), a rising tide lifts all boats. Since my interest in YHOO is significantly motivated by a short-term trade, I think the favorable seasonality leaves the shares in good shape from a sentiment perspective.

YHOO is an expensive stock trading at 23 times 2006 estimated EBITDA and over 50 times estimated 2006 EPS before stock option expense. However, in terms of growth, you get what you pay for. Current analyst estimates for 2006 call for revenue growth of 29% and EBITDA and EPS growth (ex-stock options) of over 30%. Furthermore, looking out to 2007, which is projected to grow north of 20%, sustaining the forward EBITDA multiple while making no changes to the cash balance or the value of Yahoo Japan, brings you to a $45 target. As a growth stock, YHOO has tended to trade on year ahead financial results.

So, my hope on this trade is for $45. The chart could take it there assuming the current consolidation results in a breakout to new highs. Given my desire to bring down cash and position for a bullish move in the market, buying YHOO at $40.40 provided 10% upside, sufficient to fulfill my strategy for this trade. Since YHOO was purchased with a short-term target in mind, I plan to keep it on a short leash in the event my outlook for YHOO or the market is incorrect.