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STREET WISE By Amey Stone April 8, 1999


Will Yahoo! Set the Pace for Internet Stocks?
The portal's big first quarter sets a high mark, but even if others match it, stock prices could be volatile

Internet companies will have the opportunity to prove that they really are growing as fast as their sky-high stock prices would suggest when they report first-quarter results over the next few weeks. Yahoo! (YHOO) ushered in the reporting season on Apr. 7 with results that exceeded analysts' expectations and set a positive tone for the group. But in the paradoxical world of Internet investing, surprisingly good results have become expected -- and can easily set off a round of selling.

After the close of trading, Yahoo! reported first-quarter net income of $25 million, or 11 cents a share, compared with earnings of $3.2 million, or 2 cents a share in the first quarter of 1998. Revenues were $86 million, up from $31 million in the year-ago quarter.

EXCESSIVE ENTHUSIASM. Analysts expected the company to post profits of only eight cents a share, according to First Call Corp. "I would say they handily beat estimates," says Chuck Hill, First Call's research director. "That was no surprise, but three cents is more than I would have expected." Even so, some exuberant investors had even higher hopes given Yahoo!'s past record of trouncing Wall Street's estimates. "I think the analysts have set YHOO up so the company can crush expectations," one investor hypothesized on an Internet message board before the company reported on Apr. 7. "They [analysts] say it will earn 8 cents per share when everyone knows that at a bare minimum it will hit 10 cents, really thinks it'll hit 12 cents, but also knows that there is no reason it can't put up 15 cents."

Such excessive enthusiasm partially explains Yahoo!'s pattern of trading lower after posting record results -- a pattern shared by many Internet stocks. Indeed, while Yahoo! is up 80% in 1999, profit-taking caused the stock to lose ground in two volatile trading days prior to the report's release. Yahoo! closed on Apr. 7 at 208 7/16, down from an interday high of $244 on Apr. 6.

 

"On a short-term basis, it is impossible to try and game these stocks"
 

Some analysts believe that this time Yahoo!'s stock price may not fall after the release of its results, simply because that pattern has become so widely expected. "Usually a pattern like that tends to get broken pretty quickly," says Ryan Jacob, portfolio manager of the Internet Fund (WWWFX). "On a short-term basis, it is impossible to try and game these stocks," adds Jacob. "It is better to take a long-term view and be buy-and-hold investors."

Yahoo!'s surprise raises the bar a bit for other top Internet names (see accompanying table). "I suspect, given how much they beat the numbers, there is a better chance that some of the others big Internet names might beat the numbers as well," says Hill, although he adds that some of smaller, marginal Internet companies can't be lumped in with the larger players. "I think most companies will greatly exceed expectations," says Jacob. Despite some investors' worries that advertising sales and E-commerce revenues would tail off after a strong fourth quarter, "it looks like most businesses have continued to track nicely," he says.

SUBSCRIBER GROWTH. "I don't expect any negatives from the leading companies, but some of the secondary or weaker companies could have in-line or marginally negative results," Merrill Lynch analyst Henry Blodget said during a technology conference call on Apr. 7. He expects traffic and subscriber growth to be strong across the sector, with portal traffic up 15% to 20% over the prior quarter and Yahoo! and Lycos (LCOS) registering greater gains than that. (Yahoo! reported a stunning 31% increase in page views in the first quarter over the fourth quarter 1998.) Of America Online (AOL), he said: "This could be one of the strongest quarters for subscriber growth they've had."

 

Investors shouldn't necessarily take high hopes for earnings as a cue to buy Net stocks now
 

Advertising revenues, which usually tend to be weaker in the first quarter, could be up 10% in this year's first quarter vs. last year's fourth quarter for the top-tier companies but could be flat or down a bit for weaker companies, Blodget predicts. As for E-commerce revenues, he expects Amazon to be up from the fourth quarter, but that weaker companies will be flat to down a bit compared with prior quarters.

Investors shouldn't necessarily take high hopes for Internet company earnings as a cue to buy into the sector now. With a roughly 70% gain in the sector's stocks in the first quarter, strong results have already been factored into stock prices, says Rick Berry, an analyst with J.P. Turner & Co. in Atlanta. "No matter what, revenues will be better than expected since most analysts would rather err on the low end than the high end," he says.

STILL BREAKING RULES. "I would not be surprised to see a lull or a pullback after this reporting season," says Blodget. "But we're still expecting the stocks to be higher at the end of this year." Of AOL in particular, Blodget said, "Given the run it has had, I wouldn't be surprised to see it come off after the earnings report as we move into summer."

For investors, the bottom line is that Internet stocks continue to break the rules. It can appear shockingly easy for money-losing companies to gain billion-dollar market caps. But surprisingly good quarterly results don't necessarily add up to to greater gains for investors.

Amey Stone is an associate editor of Business Week Online


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Amey Stone covers the markets and investing for Business Week Online


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Table: How the First Quarter Is Likely to Look



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