How to Play Yahoo! Inc. (Nasdaq: YHOO) Stock After Yesterday's Sell-Off

For most of the day yesterday (Tuesday), Yahoo! Inc. (Nasdaq: YHOO) stock was trading slightly up.

That was until news reports came out suggesting that the Internal Revenue Service was considering changes to tax rules governing spin-offs.

YHOO stockFearing that any future changes would affect the tax-free spin-off of Yahoo's 15% stake in Alibaba Group Holding Ltd. (NYSE: BABA), traders fled en masse. In the last half-hour of trading, the Yahoo stock price plunged 7.7%.

YHOO stock closed at $40.98. This was its lowest close since October 2014.

The recent sell-off was mostly noise. Yahoo stood firm on its commitment to spin off its Alibaba stake and the rumored IRS talks hardly present the kind of doomsday picture for Yahoo that this sudden drop would suggest.

That's why in early morning trading today YHOO stock regained some of its losses and was up 3.4% by noon ET.

And while the news sent YHOO stock sliding, it illustrates this very important point for anybody who's looking to buy YHOO stock right now...

What This Sell-Off Says About YHOO Stock

It's not groundbreaking to say YHOO stock's only true value comes from the windfall gains it promises to bring shareholders once it sheds its now-$33.6 billion Alibaba stake.

Save for yesterday's plunge - which itself was tied entirely to its potential Alibaba fortunes - YHOO stock has done a good job of tracking Alibaba stock price movements.

Beyond this there is very little to get excited about with YHOO stock.

Absent Alibaba, all that's left is a digital ad vendor that has fallen too far behind Google Inc. (Nasdaq: GOOG, GOOGL) and Facebook Inc. (Nasdaq: FB) to emerge as the top-tier Internet giant it once was.

Yahoo CEO Marissa Mayer likes to think she's duking it out with Google and Facebook, and even made a point at Fortune's "Most Powerful Women" event this week to say Yahoo is in their elite company with over a billion users.

A Fortune article also pointed out that only "Yahoo, Facebook, and Google have more than $5 billion in digital ad revenue."

While this is true to a point, it's misleading...

Yahoo made about $4.6 billion in ad sales in 2014. But it's not in a league with Facebook or Google as Fortune suggested. Facebook brought in $11.5 billion and Google pulled in an astounding $59.1 billion.

Even the "Chinese Google," Baidu Inc. (Nasdaq ADR: BIDU), made more with $7.8 billion.

If anything, Yahoo is grabbing at market share with AOL Inc. (NYSE: AOL), which raked in $1.9 billion in 2014.

And with AOL recently announcing it's putting itself up for sale to Verizon Communications Inc. (NYSE: VZ) - the real value of this second-tier online ad space vendor should really come to light.

Mayer can talk about how well Yahoo has been building up its mobile ad revenue or its so-called "native ads" - ads that are seamlessly integrated in Yahoo's news streams - but, except for a few overly optimistic shareholders, nobody seems to care.

Mostly that's because all of Mayer's strategic initiatives to bring Yahoo up to snuff with the competition aren't changing the game. Google is selling ads against the most sophisticated, highly used search property on the planet. Facebook is selling ads against the most engaged social media audience on the planet.

Yahoo is where businesses go with their leftover advertising budget not already being spent on Google and Facebook.

Native advertising is not new nor is mobile advertising. Yahoo's not doing this because it stumbled on some new game-changing business model, but rather because advertising trends made it a necessity for their survival.

That's why at the last Yahoo earnings presentation questions about Yahoo! Japan, in which Yahoo holds a 35.5% stake, began heating up...

How Yahoo! Japan Affects YHOO Stock

Yahoo! Japan is somewhat impressive only for the fact that in Japan it's the No. 1 search engine, edging even Google. Yahoo's two billion shares are worth $8.8 billion. This matters to shareholders who are only looking to wrestle as much money out of Yahoo as they can and then leave.

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It's likely to be the last source of value Yahoo has after it spins off Alibaba, albeit, a very minimal one. But the fact that shareholders are even inquiring about a rather uninspiring holding in the first place shows their only interest is to see every dollar of value to Yahoo's name be distributed to them.

"Ironically enough, Yahoo! Japan is still the big search engine in Japan. It's one of the few places on earth where that's the case," Money Morning Chief Investment Strategist Keith Fitz-Gerald said. "Japan is the last growing fax market too. Strange things have happened. So, I don't think Yahoo! Japan is going to move the needle enough."

Activist investor Jeffrey Smith of Starboard Value LP even recommended Yahoo look to monetize its real estate and give those proceeds to shareholders.

That's what value YHOO stock has right now. It's sitting on a rather big pile of cash with Alibaba. Yahoo investors are just looking for whatever way they can to increase that pile, however minimally.

And from there, the possibility of a sale to Alibaba - if Yahoo comes to the same realization AOL did - would just sweeten the deal.

The Bottom Line: YHOO stock is a mediocre play when you're just looking at the company, but it still has a big future cash flow coming its way that's going to be funneled to shareholders in some way. This is why it was a little odd that on vague IRS news a lot of traders chose to jump ship so early. If you're looking to play YHOO stock for whatever gains it's going to get as shareholders squeeze as much value as they can out of it, there's no better time than now - after an overreaction sent shares plunging into oversold territory. But if you'd rather find a long-term investment in tech, you're better off here.

Jim Bach is an Associate Editor at Money Morning. You can follow him on Twitter @JimBach22.

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