Will Yahoo! Inc. (YHOO) Take a Dive After Taking a Tumblr?

Yahoo! Inc. (NASDAQ:YHOO) stock has been on a tear rising over 70% since Marissa Mayer became CEO in 2012. This rate of price appreciation is probably not sustainable because the increase in share price has come about for reasons that have little to do with day to day operations.

Yahoo! Inc. (NASDAQ:YHOO)There are three main reasons for the price increase. The first is the Asian assets represented by Yahoo! Inc. (NASDAQ:YHOO)’s stakes in Alibaba and Yahoo! Japan. These were smart early investments by Yahoo!, and the company would not be in business today without the asset value of these holdings and the cash obtained from a partial sale of the Chinese internet company Alibaba.

The second reason for the price appreciation has been a $3.6 billion stock buyback using some of the proceeds from the Alibaba sale. A stock buyback is basically a statement by a company that the Directors do not believe that the company’s business model warrants additional investment. Yes, Yahoo! has been making some investments by acquiring some small tech firms and Tumblr, but the buyback is designed simply to reduce the number of outstanding shares. Fewer shares outstanding makes the earnings per share look better.

The Alibaba investment was one of the only smart moves Yahoo! Inc. (NASDAQ:YHOO) management made in the previous decade. A $1 billion investment in 2005 has already yielded $7.4 billion in realized gains. Some analysts believe that Yahoo! stands to make another $20 billion as it liquidates its remaining 24% stake in Alibaba

The final reason is the euphoria regarding the hiring of Marissa Mayer as CEO. After having six different Chief Executive Officers over a period of 10 years, Yahoo! finally seems to have found a CEO who can articulate a vision for the future and raise the flagging moral of the employees.

The problem with Yahoo! Inc. (NASDAQ:YHOO), from an investment stand point, is that all the good news is already reflected in the stock price. So, any future gain needs to come from improvements in the day to day operations of the company. Here things do not look so good.

Yahoo!’s primary business is as an internet portal and search engine that makes its money by selling advertising. Unfortunately for Yahoo!, internet advertising revenue has been dropping over the last year. Rivals Google Inc (NASDAQ:GOOG) and Facebook Inc (NASDAQ:FB) have been experiencing increased ad revenues over the same period of time. Google revenue was up 21% and Facebook had a gain of 37%.

Google Inc (NASDAQ:GOOG) has a significantly greater audience reach as it has the number one search engine and Android is the most widely used mobile phone operating system. Google Inc (NASDAQ:GOOG) has major social media platforms with both YouTube and Google+. Yahoo! Inc. (NASDAQ:YHOO) just does not have anything that can compete and must settle for trying to hold onto a profitable second tier position.

Facebook Inc (NASDAQ:FB) has ten times the active users as Yahoo! Inc. (NASDAQ:YHOO)’s latest acquisition, Tumblr. Facebook has also been making big strides at mastering mobile. Its latest strategy of focusing on providing a strong platform for local advertisers has been successful and probably makes Yahoo! wish it still had Geo Cities.

Yahoo! has been relying on the outdated concept of the internet portal as the primary source of its earnings. The huge increase in mobile, where people get the same kind of information through apps, has been leaving Yahoo! Inc. (NASDAQ:YHOO) behind. The company is just starting to implement a mobile strategy and will have a struggle to catch up to its competition. The best Yahoo! can hope for is to keep making cash a profit as a member of the also ran tier of companies while it attempts to come up with a strategy to stay relevant.

Tumblr might be Yahoo!’s savior but Tumblr’s prospects could go either way. It could either hold onto its users base and start producing revenue or be abandoned as users look for the next hot thing. Only time will tell because you just never know with the internet.

Yahoo! Inc. (NASDAQ:YHOO)’s fate will play out over the next couple of years. At the moment, however, it violates one of the main rules of fundamental investing. Never buy at the top when all the good news is already reflected in the stock price. The strategy for believers in Yahoo!’s future would be to look for buying opportunities that come on dips caused by negative news.

While the current business model may be weak, I do believe in the current management. The chance of a dive is small because most of the recent gains are due to the Alibaba investment. A dive would require some extremely negative news. Therefore, this is a stock to watch. If the company shows signs of making the transition to mobile or the Tumblr acquisition starts to payoff, buy.

The article Will Yahoo! Take a Dive After Taking a Tumblr? originally appeared on Fool.com and is written by Eric Whiteside.

Eric Whiteside has no position in any stocks mentioned. The Motley Fool recommends Facebook Inc (NASDAQ:FB) and Google. The Motley Fool owns shares of Facebook and Google Inc (NASDAQ:GOOG). Eric is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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