Call it the myth of Yahoo! ( YHOO).Every three months, the market grows excited about Yahoo!'s earnings (this quarter's earnings are slated for release Tuesday). Either the company is riding the bull market in search-related advertising, or it's getting hit by the backlash in overvalued search stocks. Either way, the underlying story is that, aside from Google ( GOOG), there is no major Internet stock with greater long-term growth prospects than Yahoo!. In the business world, there's a lot of truth to this. Yahoo! has great managers at its helm. It hasn't rolled out a lot of duds in the past few years, and has focused on areas that have revenue growing by 47% a year. The biggest advertisers trust it, as do the 400 million users who visit its site each month. The problem is, none of this has been reflected in Yahoo!'s stock in any significant way. During the past two years, shares of Yahoo! have basically gone sideways. Except for a brief dip below $26 in August 2004 and a brief blip above $43 in January of this year, it has pretty much traded in the $30's. Over the past year, the average adjusted closing price of the stock was $34. And over the past two years, the adjusted closing price of the stock was -- that's right -- $34. Which means that if, two years ago, you had decided to buy Yahoo! every day it traded below $34 and to short it every day it traded above $34, you would certainly have made out better than those who bought and held the stock for two years -- and almost certainly better than those who tried to play the earnings game with the stock. Sure, it's easy to strategize in hindsight. And sure, lots of stocks trade within ranges for long periods of time. But most range-bound stocks don't have revenue growing nearly 50% a year, and few have held on to reputations as one of the few large-cap growth stocks in town.
This is quite a different story from Google, whose stock has truly benefited from the surge in Internet advertising. Two years ago, Google was still getting ready for its IPO. Since its debut in August 2004, Google shares have risen 380%. Given that search advertising is often estimated to make up a little more than one-third of Yahoo's total revenue, and given that the other two-thirds comes from banners and premium services that are growing at a still-healthy rate, if not as fast as search, you'd expect Yahoo!'s stock price to have doubled at a minimum over two years. Instead, the stock, which closed Thursday at $32.23, is at the same level it was at in February 2006 -- not to mention September 2005 ... March 2005 ... and September 2004. Part of this stagnation is reflected in the increase in the number of shares outstanding. Yahoo has 1.41 million shares outstanding, compared with 1.39 million a year ago and 1.35 million two years ago. This is about a 5% increase over two years, but it explains only a part of the lackluster stock performance. There's also the weak profit expected from Yahoo! this year. The company's operating margin shrank to 13% in the first quarter of 2006, down from 21% in the same quarter a year earlier. And analysts polled by Thomson FirstCall are expecting the company's 2006 profit to weigh in at 53 cents a share, down from 58 cents in 2005. But that disappointment has been priced into the stock. Analysts are bullish on Yahoo's earnings in 2007, when they see it growing 34% to 71 cents a share; and again in 2008, when they forecast growth of 37% to 97 cents a share. Of 38 analysts covering the stock, 29 rate it a buy or strong buy. Only one rates Yahoo a sell. And yet, it's almost as if investors are tuning out that bullish thinking, which is something of a mystery. Perhaps the answer lies in data from research outside Wall Street. ComScore said Google's share of the U.S. search market has grown to 44% from 41% in just the last five months, while Yahoo!'s share has stayed around 28%.
But there's reason to think Yahoo! may benefit from an unexpectedly strong second quarter. In May, search-query volume grew 43% from a year earlier, well above the 12% growth rate during the first quarter of 2006, ComScore said. Again, Google is driving this growth: Its May volume surged 68%, compared with Yahoo's below-average growth rate of 33%. Analysts have been calling for a strong second-quarter performance from Yahoo! Piper Jaffray and Susquehanna issued reports this week calling for a positive earnings surprise from Yahoo! and a subsequent pop in its stock. That might just be enough to get shares back to $34. But it's going to take a lot more than that to turn the Yahoo! myth into reality.