NEW YORK (CNN/Money) -
If an Internet stock is ludicrously overvalued but nobody seems to care, will its stock keep going up?
In the case of Yahoo!, the answer seems to be yes.
Yahoo! surged 175 percent in 2003 and on Tuesday the stock briefly crossed the $50 barrier for the first time since November 2000. Shares now trade at 90 times 2004 earnings estimates.
But that doesn't seem to faze investors as they prepare for Yahoo!'s fourth quarter earnings report on Wednesday.
"The type of investors who own this stock are not looking at it saying, 'I'm willing to pay 80 times earnings for this stock but not 85 times earnings,'" said Ethan McAfee, an analyst with hedge fund Capital Crossover Partners. "They own it because it's growing fast." McAfee's firm does not have a position in Yahoo!
Great quarter, great year ahead
Henry Hewitt, manager of the Light Revolution fund, owns Yahoo! but concedes that valuations are now "in outer space." Still, he said fundamentals would have to deteriorate for him to change his mind on the stock. And that doesn't appear to be likely.
"Yahoo! makes money and I'm looking for the best quality companies in certain sectors," said Hewitt. "I'm not going to trade out of the stock because the P/E is too high."
Analysts are forecasting earnings of 11 cents per share for the fourth quarter, up from 8 cents a year ago, and a 73 percent increase in revenues, to $495.1 million. Yahoo! (YHOO: Research, Estimates) will need to do more than simply hit these targets in order to satisfy the momentum investors that have bid up the stock. But odds are, it will deliver.
Imran Khan, an analyst with Fulcrum Global Partners, said Yahoo! is benefiting from an improved market for advertising and this will probably lead Yahoo! to give a rosy outlook for the first quarter and beyond. For the full year, analysts are forecasting earnings growth and sales growth of 49 percent.
Still, there are several risks that investors need to be aware of before jumping in at these levels.
Here comes Google
Yahoo! is hoping to gain from the increased popularity of so-called paid search listings, which allow advertisers to sponsor keyword searches. Advertisers are finding this method of online advertising to be more effective than banner ads and pop-ups.
But Yahoo! currently relies on Google's search technology for its sponsored searches with an ad-sharing agreement, and there have been reports that Yahoo! will soon get out of the deal.
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Yahoo! has spent nearly $2 billion on acquisitions in the past few years, scooping up search companies Inktomi and Overture Services, so that it could build its own search capabilities to rival Google. Wall Street will soon find out whether Yahoo! spent its money wisely.
Gene Walton, an analyst with independent research firm Walton Holdings, notes another Google threat. Walton thinks that if Google goes public this year that could put pressure on Yahoo!'s stock since there will be a new kid in town for momentum investors. Given that Google is a younger company, it's growth potential will probably look even more appealing than Yahoo!'s.
"There will be less scarcity value for Yahoo!" Walton said.
In addition to search, Yahoo! is trying to jump-start its other fee-based businesses, meant to reduce reliance on fickle advertising. Yahoo! still depends on ad sales for more than two-thirds of its business.
Khan said Yahoo!'s co-branded DSL offerings with SBC in the U.S. and British Telecom in the U.K. are doing well. But he said Yahoo!'s job listing business (it bought HotJobs in 2002) faces tough competition from Monster Worldwide, which runs Monster.com, and Careerbuilder.com, which is owned by newspaper publishers Gannett, Knight-Ridder and Tribune.
Bears staying away
Despite these concerns, even short sellers, investors who bet that a stock is heading south, are steering clear of Yahoo! The shorts held only 5.6 percent of the stock's float, or available shares outstanding, as of mid-December.
That's down from a level of nearly 7 percent in mid-September, just before Yahoo! reported strong third quarter results.
So even though Walton thinks that Yahoo!'s valuation is "getting ridiculous", he wouldn't recommend betting against it.
"Unless I see downside in Yahoo!'s business fundamentals, I won't assign a negative rating to the stock. There are other companies where the valuations aren't as out of line but the fundamentals are bad so they are better shorts," Walton said.
Analysts quoted in this story do not own Yahoo! and their firms have no investment banking relationships with the company.
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