This article was originally posted at RealMoney on Sept. 11, 2007.

As I noted in my Motorola column, I like to take a look at the stocks with unusual option activity on StockPickr to see if there is anything sufficiently interesting to investigate further. Friday’s list was a doozy, with heavy activity listed for deep out-of-the-money October calls for Motorola (MOT - Annual Report), Arch Coal (ACI) and Yahoo! (YHOO). Having found a possible long-term bargain in Motorola I turned my attention to Yahoo! to see if I could pull a two-fer. Alas, it looks as though I may have bagged my limit.

Unlike Motorola, Yahoo! has no chance at a bloodletting fire-the-CEO rally (justified or not) because it has already happened. Instead, any hopes for a short-term pop in Yahoo! shares are probably underpinned by the persistent buyout rumors, with Microsoft (MSFT - Annual Report) and EBay (EBAY) being the buyers most frequently bandied about. But the problem with those rumors is they have been around forever, and so far smoke has yet to signal fire. Anybody buying the name in hopes of a buyout should therefore be prepared (and paid) to wait.

So, will Yahoo! reward a patient approach? It doesn’t look that way to me. Its free cash flow in 2006 was $700 million, half the level achieved in 2005. It is only good for a 2.3% free cash flow yield on the current enterprise value. That means essentially all of the return potential has to come from growth - which doesn’t seem like a safe bet given last year’s decline. Sure, the growth rate over the last five years is nearly 45% - but that is coming off of the lowest lows of the Internut Bust. The consensus five-year growth estimate is 24%, including a 20% decline in the current year. By implication, that means the subsequent four years would have to post average growth of nearly 40% annually. Color me skeptical. With an ROE of just 8.27%, assuming growth will be faster than that implies adding debt or issuing new shares unless they can somehow boost the ROE itself - a feat far easier said than done. Coincidentally (or not) that is about in line with the actual year/year growth rate in the latest quarter.

I know, I know - that’s all just academic theory. So let’s consider Yahoo’s businesses to get a feel for what the company can do to boost that ROE and ramp up the earnings growth. According to the latest 10Q, fee-based businesses such as premium mail, web hosting and premium Flickr accounts contribute just 12% of revenue. While they may grow, it is hard to imagine them growing enough to move the needle. That leaves “marketing services” such as HotJobs and display advertising. Somehow, the latest employment report leaves me less than fired up about HotJobs’ prospects. As for display advertising, financial services firms have accounted for anywhere from 12% to 30% of online advertising. A good chunk of that is mortgage refinancing and credit cards - both of which seem likely to suffer as credit standards return to historic norms.

Yahoo! is a great company, with a balance sheet strong enough to carry them through any downturn in the online advertising market. But they aren’t generating enough cash flow today to make waiting for the recovery worthwhile - at least not for me. There are other companies out there that look like safer bets. While Yahoo! could very well return to growth, it just looks too hard to earn a return high enough to compensate for the risk.