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Internet stocks: Great expectations
Yahoo! couldn't live up to them. eBay surpassed them. But investors should focus on the long-term.
July 21, 2005: 2:32 PM EDT
By Paul R. La Monica, CNN/Money senior writer

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"Net" losses: It's been a tough year for investors in eBay and Yahoo! so far this year.
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NEW YORK (CNN/Money) - Investors are a fickle lot, especially owners of Internet stocks.

Yahoo! reported on Tuesday that its earnings, excluding a big gain from the sale of part of its investment in rival Google, increased 70 percent from a year ago. And sales, factoring out revenues the search engine company shares with affiliates, surged 44 percent.

So what happened on Wednesday? Shares of Yahoo! (Research) plunged 11.5 percent. Huh?

The problem was that Yahoo! didn't beat quarterly earnings per share targets. It merely met them. Sales actually missed by a small amount. And the company didn't raise revenue estimates for the full year either.

Yahoo! is a perfect example of why longer-term investors should probably not pay that much attention to short-term results. When traders start whispering about how much a stock can crush estimates by, a quality company like Yahoo! often gets punished for what speculators find to be disappointing numbers.

That's just silly. To suggest that Yahoo! was a disappointment or that investors should now be concerned about a looming online advertising slowdown because it didn't raise its sales target for the year is absurd. Sales are still expected to be up a stunning 41 percent from a year ago.

And history teaches us that a rapidly growing company often bounces back once investors lower their expectations to more reasonable levels. That's exactly what happened with eBay (Research) following the release of its second quarter results on Wednesday.

The online auction giant beat sales and earnings targets for the quarter and boosted its earnings outlook for all of 2005. As a result, shares shot up nearly 18 percent Thursday morning.

Prior to that though, the company had been in Wall Street's penalty box all year (shares are still down nearly 30 percent even with Thursday's surge) because the sales and earnings guidance it gave Wall Street for 2005 in January was below what many were expecting.

This caused skeptics to come out of the woodworks to declare that eBay was in trouble for various reasons. They worried about increased competition, dissent from users due to recent fee increases, slowing growth in the U.S. and Europe and that investments in new businesses and markets might not pan out.

But eBay's new guidance appears to be convincing some that many of these fears were for naught.

Take the long-term view

The important lesson here is that buy-and-hold investors interested in these stocks should try not to get caught up in the day-to-day obsession with short-term reports. Leave the worrying about missing or beating by a penny to the speculators and day traders.

Their results have been volatile in the past and probably will continue to be in the future. In fact, eBay and Yahoo! both plunged last July after reporting second quarter results, in part due to fears that a seasonal slowdown in Internet usage during the summer months was a portend of bad things to come in the long-term. That's not rational.

"These businesses are not meant to be managed on a quarterly basis but people take quarterly results and extrapolate them to come up with a long-term value for the stocks," said Scott Devitt, an analyst with Legg Mason. "You have to look at them with time horizons of two or three years, not two or three months."

Investors just need to remember that there is a lot of risk with Internet stocks. When companies are subject to absurdly high expectations and trade at a premium valuation (Yahoo! and eBay both have P/E ratios above 50) there is going to be the occasional big sell-off in the short-term.

The key is to not panic and misinterpret a negative reaction to a small miss as being a sign of an impending financial collapse. Earnings for both companies are expected to increase at a 30 percent clip on average for the next few years, well ahead of the growth rate for the broader market.

"The future of these two companies is bright," said Scott Kessler, an equity analyst with Standard & Poor's. "There are growth opportunities not just here in the U.S. but internationally. The companies are not going away anytime soon, notwithstanding any near-term fluctuation in the stocks."

The same obviously could be said of Google (Research), scheduled to report its results on Thursday.

Shares are up nearly 270 percent since the company went public last year and the stock trades at about 60 times earnings estimates for this year. Expectations are extremely high, with analysts forecasting a more than two-fold increase in earnings and a nearly 100 percent jump in sales.

So there's the risk of a sell-off if sales and earnings "disappoint.", i.e. if growth comes in at just 90 percent. But savvy investors with a longer view though should take advantage of a pullback if there is one.

For a look at more Internet stocks, click here.

For more coverage of earnings season, click here.

Analysts quoted in this story do not own shares of the companies mentioned and their firms have no investment banking relationships with the companies.


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