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Yahoo! Basking in Panama Premium

The new ad system wins fans, spurring a big rally.



eagerly anticipated new advertising system shows signs of performing well so far.

But before investors hitch a ride on the stock, they would be wise to take a close look at its soaring valuation.

On Monday, research firm comScore released data showing the click-through rate on ads displayed next to Yahoo! search results had increased since the launch of the Panama system two weeks ago.

The week ending Feb. 11 saw a 5% increase in click-throughs compared with the previous week, while the week ending Feb. 18 saw a 9% gain, according to the data.

What's more, gains per week also have increased. The gains from Panama were 4 percentage points higher in its second week after launch than during its first. The increasing gains in click-through rates are a result of Panama being able to determine which ads generate more click-throughs and which, in turn, to place more prominently, notes James Lamberti, a senior vice president with Comscore.

The week-over-week growth is higher than expected, says Lamberti. And "as the system is trained and Yahoo! continues to calibrate it, we should see a further lift," he says.

Higher click-through rates were a key goal for Panama, which serves up ads based on both their relevance to users along with the price that advertisers bid.

The new approach is similar to what is used by rival


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and is expected to be more effective at getting users to click on ads compared with Yahoo!'s old system of ranking ads only by how much advertisers were willing to pay.

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With more click-throughts overall, Yahoo! ultimately hopes to garner more revenue from its search business.

While the data cover too short a period to approach anything definitive, they should bolster the positive sentiment surrounding Panama that has been brewing on Wall Street. "We remain positive on Yahoo! as it appears that the Panama launch did not create a marketplace disruption (a 1Q risk), and believe that Yahoo!'s search monetization rates could be tracking ahead of early (1Q) expectations," Merrill Lynch analyst Justin Post wrote in a research note on Monday morning. Merrill Lynch makes a market in Yahoo! shares.

Shares of Yahoo! closed Monday up 2 cents to $32.12.

Still, despite the tailwinds, investors should be wary of the stock's valuation -- especially in light of its recent run-up. Yahoo! trades at a multiple of 44.6 times future earnings compared with Google's 25.7. The disparity is even more striking considering that Google is expected to grow its earnings per share much more quickly than Yahoo!, which has a price-to-earnings-to-growth (PEG) ratio of 2.38 compared with 1.02 for Google.

But investors may consider Google -- which relies almost solely on search ads for revenue -- to have riskier growth prospects than Yahoo!, thereby justifying the higher multiple. Indeed,

Google has sustained some high-profile setbacks in trying to enter new markets lately. Its stock traded at $464.93 on Monday, off more than 9% from its highs in November.

Yahoo!, meanwhile, has soared 42% since its lows in October. Along with Panama, the company also has launched a flurry of promising new initiatives since the beginning of the year, including rolling out a mobile-ad network, introducing a new mobile-search offering and beefing up its email and instant messaging services.

Yahoo! also has made it clear that it sees itself as a prime beneficiary of the continued growth in online advertising. Earlier this month, during a no-frills pitch to about 1,000 advertisers and ad executives, Yahoo! pointed out that 17% of media consumption is now online, whereas only 6% of media dollars are now being spent there.


Yahoo!'s rally and rich valuation raise questions about how much upside may be left. Analysts surveyed by Thomson/First Call place an average 12-month price target of $33.06 on the stock, meaning that its run may be all but up, even in light of Wall Street's general optimism. Merrill Lynch's Post, while bullish, has a price target of $33, for example.

Citigroup's Mark Mahaney, meanwhile, places a $35 price target on the company and also issued a bullish research note about Panama on Monday. But he wrote that in the wake of the recent run-up, a further uptick likely would require an increase in guidance.

"Our major caution here is that with the 26% YTD surge in YHOO shares, more than 10% in the shares from here would likely require an increase in estimates -- something which there is still limited visibility into," wrote Mahaney. "But we have increased conviction in that 10% upside movement from here." Citigroup makes a market in Yahoo! shares.

Still, that's a risky scenario for investors looking to get behind Yahoo! now. While positive snippets of evidence continue to roll in, it may well take an actual boost in Wall Street's earnings expectations for the stock to continue its rally.

But at its current valuation and recent performance, it would take much less for the stock to give back what it's gained so far.