Sell Yahoo!? S&P's Kessler thinks it's time to dump the stock

The McGraw-Hill Companies Inc.'s (NYSE: MHP) S&P downgraded Yahoo, Inc. (NASDAQ: YHOO) to sell. I spoke with Scott Kessler this morning who told me that he estimated that it's worth $28 a share and since it's currently trading above it's value, at $29, it makes sense to sell it.

Kessler made an observation which I found intriguing -- that there is often a disconnect between analysts' recommendations on a stock and their target prices. More specifically, he often finds that analysts keep a buy recommendation on a stock even though it is trading above that analyst's target price. In my view, when an analyst is employed by an investment bank, there is an economic incentive to keep a buy rating on a stock -- particularly when the bank is earning revenues from other business relationships it has with that company.

S&P does not do investment banking and it judges itself on whether its stock recommendations make money for investors. Thus Kessler felt it was important to change his recommendation once Yahoo exceeded his target price of $28. Kessler developed this estimate by developing a discounted cash flow (DCF) analysis of Yahoo's core business and adding to that the value of Yahoo's minority stakes in various publicly-traded companies, such as Alibaba, a Chinese Internet company.

Kessler had a mixed interpretation of Yahoo's conference call. He was pleased that Yahoo reported 30% growth in revenues from its top 200 advertising customers. But he also believed that there was significant negative sentiment about Yahoo based on several 2006 operating disappointments -- such as the delay in introducing Panama. In Kessler's view, The positive reaction to its latest announcement has balanced the negative sentiment and may also be overestimating the income statement benefit from Panama.

Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm, a Professor of Management at Babson College, and editor of The Cohan Letter. He has no financial interest in the securities of Alibaba, McGraw-Hill or Yahoo.