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Investors Dunk Yahoo

Wall Street analysts maintained their positive expectations of Yahoo even after the company earnings report this week highlighted a downturn in profits and product delays.

Don't worry, investors, Merrill Lynch said. Yahoo will enjoy long-term growth. And Cowen and Company said Yahoo will grow as online advertising grows.

Yahoo reported yesterday their profits dropped 78 percent from a year ago. The company met earnings estimates of 11 cents a share, but revenue after traffic acquisition costs of $1.12 billion, while up 28 percent, came in below the $1.14 billion forecast.

Yahoo's actual revenues were up by 26 percent to $1.6 billion for the second quarter from $1.3 billion during the same time last year. But its profit is what set off alarm bells. Net income was $164 million (11 cents per share), down by 78 percent from the $754 profit (54 cents per share) it tallied for the second quarter of last year.

Adding fuel to its earnings fire, Yahoo also announced delays in rolling out its new ad system.

Despite the negative numbers, analysts urged investor caution, saying the numbers do not correlate to Yahoo's core business: brand advertising. But their advice didn't take. Yahoo shares were down over 21 percent to $25.59 at press time.

Analysts at Cowen and Company think profit fall off is beside the point.

"We expect Yahoo to benefit from the secular growth trend in online advertising, driven by its dominant position in graphical advertising," said Cowen analyst Jim Friedland in the company's "Morning Call" research report.

The suggestion is that after watching Internet advertising increase 30 percent in 2005 and recognizing that Yahoo is a leader in selling Internet brand advertising, investors should not overreact to the negative numbers.

Some evidence may support the assertion.

Yahoo measures its own success by a metric called engagement, which is the length of time visitors spend on a site.

Yahoo uses this metric and vast amounts of demographic data to sell space to brand advertisers.

Last quarter, according to Yahoo's published financial results, Yahoo's visitors spent more time on its site, and brand advertising revenue went up.

But Yahoo Search advertising revenues did not.

And the announcement that Yahoo's new search advertising system was delayed probably did not hearten investors, either.

Merrill Lynch analyst Justin Post cautions investors to remain neutral in a report entitled "More patience required."

"With user engagement increasing, branded CPMs [cost-per-thousand] as low as $4, and search monetization improvement still to come, we believe Yahoo can achieve 25 percent long-term growth even as user growth falls below 20 percent."