Yahoo: After the Plunge

Once again Yahoo framed its quarterly results with bullish-sounding profit and cash flow forecasts and impressive statistics about its international reach and the growth of user traffic. The "highest share of time spent on the Internet," is one of Yahoo's many claims of greatness for itself, and yada, yada, yada.

But investors ignored the self-adulation and massacred the stock on Wednesday. The shares sank 22%, to $25.20, for two reasons, one short-term and one longer-term. The short-term reason was, simply, that Yahoo's second-quarter earnings of 11 cents per share trailed analysts' expected earnings of 13 cents per share; revenue results were also underwhelming. Looking further ahead, Yahoo announced that it needs more tests of its new advertising infrastructure, which will not be ready now until the fourth quarter of 2006. Because Yahoo collects 85% of its revenue from advertising and marketing and only 15% from users' fees, anything that puts its ad income at risk or pushes it into the future is a problem.

So when CEO Terry Semel spoke to analysts after the stock market closed on Tuesday, it was Yahoo's disclosure about the advertising interface delay that dominated the question period that followed. When analysts subsequently commented about Yahoo's stock (symbol YHOO), the tone was not upbeat. Even as they reiterated their belief that Yahoo was a good company, many analysts reduced their target prices to the middle $30s from the $40 area.

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Given that Yahoo is now well below those target prices, the stock would seem to be a bargain. The fact is, though, that Yahoo is more difficult to predict than the typical stock. Yahoo executives made it plain on the conference call -- repeating something they have said before -- that they don't believe in managing earnings to produce quarterly results that please analysts. So every three months, when quarterly earnings are released, Yahoo shares are likely to make a big move. It could be up, or it could be down.

A pertinent question is whether this disaster has any spillover effect or, more accurately, what it would spill over to. Yahoo is part of a group of Internet leaders that include eBay, Google and Amazon. Originally, these were all considered technology stocks, and they still count a lot in the Nasdaq index, which is usually described as a window on how tech is doing. But because these companies derive their income from advertisers and consumers, the stocks of Amazon, eBay, Google and Yahoo shouldn't be viewed in the same way as one might view Cisco, Hewlett-Packard and IBM.

The big Net stocks turned in mixed results on Wednesday, so the Yahoo report didn't result in indiscriminate selling throughout the sector. By contrast, shares of traditional hardware and software moved up nicely, along with the rest of the market. For these companies, the key issue is corporate spending on information technology. And that, to a great extent, depends on the overall health of the economy.

Another thought to glean from the Yahoo disaster: It might be a sign that investors are accelerating their shift from more-speculative stocks to higher-quality names. In today's chancy environment, investors seem to be placing more of a premium on stable earnings growth, dividends and strong finances -- the kinds of yardsticks usually associated with companies such as General Electric, IBM and Microsoft. If fund managers, strategists and other experts are right about this shift in investor sentiment, it may be a while before Yahoo once again becomes a market favorite.