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Throw This Stock Away

Your portfolio needs a spring cleaning. You know it. I know it. The only thing left is for you to decide what to keep and what to toss away.

It's not an easy decision. We begin rooting for the home team, and that cheerleading passion can sometimes blur the reality of improving teams elsewhere.

So kick the pompons to the curb. Let's pick a stock, point out both its promise and its flaws, and then go on to replace it with a few related stocks that may outperform it during the coming months and years.

This week's throwaway? Come on down, Yahoo! (Nasdaq: YHOO  ) .

The downside of upside
I boiled down the art of investing to two simple questions last month: What can go right? What can go wrong? In its most fundamental form, that is what dictates any stock's direction.

Yahoo! is a perfect candidate. The upside is fairly limited in the near term. The stock is trading at a high multiple relative to its faster-growing peers; institutional investors are prodding Yahoo! to get back in bed with Microsoft (Nasdaq: MSFT  ) .

So what is the Yahoo! upside? If it all comes down to Carl Icahn taking control of the board and coaxing Microsoft to reintroduce its $31 offer, we're talking about a gain of 16% off of Friday's closing price. Getting Microsoft to repeat its informal $33 offer would be an uphill challenge, but even there we're talking about only a 23% difference.

If this was something an investor could pocket sans risk in a few weeks or even months, it would be a sweet trade.

It isn't. The Yahoo! board vote won't happen until the end of next month. After that, no one knows how long it could take to woo Microsoft again. And even if a buyout is agreed on, the deal is unlikely to close this year.

Have you seen regulators sit on the satellite radio deal, keeping XM (Nasdaq: XMSR  ) and Sirius (Nasdaq: SIRI  ) apart for nearly 16 months? Microhoo will get an easier pass domestically, but it also faces still bigger tests abroad, like the stingy European Union that has always had it out for Microsoft. Since Microsoft doesn't have the greenery for an all-cash deal, the value of the deal may also erode as investors wait. Ouch.

The upside of downside
The near-term upside is limited, but the downside is not. As soon as Microsoft is out of the question -- either through a little more conviction in its exit strategy or regulatory fears -- Yahoo! will be valued on its own merits.

It won't be pretty. The stock was trading in the teens before Microsoft's offer, with half of that backed by Yahoo!'s once timely Asian investments, which have shrunk in value in recent months. Along the way, Yahoo! has issued layoffs, lost market share, and even had a board member defection.

Meantime, Yahoo! begins this week trading at 57 times last year's earnings. It is also trading at 57 times this year's Wall Street profit target. In other words, that's a pretty lofty multiple for a company that isn't supposed to grow its bottom line this year.

Microsoft may never leave the picture, but it's hard to argue that Yahoo! wouldn't be valued back in the high teens -- or even the mid-teens -- if Microsoft had never bellied up to the bar.

Yahoo! has some long-term upside, but it will take a couple of years of growth to justify its current price tag.

Switcheroos for Yahoo!
What's an investor to do? If you are looking to replace Yahoo! in your portfolio, I have a few ideas:

  • Google (Nasdaq: GOOG  ) -- You can get the faster-growing market leader at a lower market multiple than Yahoo!. Perhaps more importantly, Google is poised to win no matter which way Yahoo! goes. If Microhoo receives regulatory approval, Google will no longer be handcuffed in pursuing its own deals. If Microhoo falters, Google can just recruit the pick of the litter from Yahoo! or simply outsource its ads through Yahoo!.
  • (Nasdaq: BIDU  ) -- China's leading search engine isn't necessarily cheaper than Yahoo!. It is trading at 52 times next year's earnings estimates. However, Baidu is growing quickly in a country that is just starting to migrate to the Internet. Despite Baidu's market leadership, chunky margins, and clear path to explosive growth, it commands a market cap that is only one-third of sluggish Yahoo!'s.
  • IAC (Nasdaq: IACI  ) -- The parent company of is ready to split into five segments, giving investors the opportunity to buy into its fast-growing online arm without being dragged down by the company's ticketing, retail, and lending slowpokes. In the meantime, value hounds that are scoffing at paying 57 and 29 times this year's profit guesstimates for Yahoo! and Google, respectively, can get IAC at just 14 times this year's earnings.

Do you like my substitutions? Would you rather stick it out with Yahoo!? What other stocks should I look at in future columns? Let me have it with the comment box below.

Microsoft is a Motley Fool Inside Value recommendation. Yahoo! is a former Stock Advisor selection. Baidu is a Rule Breakers pick. You don't need a spring cleaning crusade to unearth any or all of the newsletter services. You can try a free 30-day subscription to see which one fits you like a white glove.

Longtime Fool contributor Rick Munarriz is a fan of Yahoo! and Microsoft but not of bad weddings. He does not own shares in any stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 06, 2008, at 10:57 PM, clindfool wrote:

    I'm new to this scene but I recommend you talk @ Starbucks or Costco. Maybe you already have?

  • Report this Comment On June 08, 2008, at 5:52 PM, Vince1172 wrote:

    I dunno if it's fair to say Yahoo was trading in its "teens" before the Microsoft offer. Hate to split hairs but... technically yes. It was in its "teens." But it was trading in its EIGHTeens. 18.58 was its low. The high end of the spectrum. Not thirteen or fourteen.

  • Report this Comment On July 22, 2008, at 2:44 PM, KWT8011 wrote:

    good call on yahoo, but non of the three alternatives have been much better...

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