2 Stocks to Brave the Internet Software & Services Industry – November 24, 2021

The outlook for the Internet-Software & Services industry appears negative going by the estimate revision trend over the past year, driven largely by the pandemic. Some companies were however positively impacted by the pandemic and the rush-to-digitize trend that it gave rise to. The diversity of players in this group is the reason for this dissonance.
 
Being the backbone of the digital economy, it’s hard to see this industry doing badly over the long term. However, the near-term outlook could have been better. To make matters worse, valuations are going through the roof. Under the circumstances, Criteo (CRTO) and Donnelley Financial Solutions (DFIN Free Report) are the only ones warranting a closer look.

About The Industry

The Internet Software & Services industry is a relatively small industry primarily involved in enabling platforms, networks, solutions and services for online businesses and facilitating customer interaction and use of Internet based services.  

Three Themes Driving The Industry

  • The overall impact of COVID has been mixed for the industry. Although it necessitated work from home for employees, the industry, being by nature tech-centric, had relatively fewer issues with this. On the other hand, business continuity concerns accelerated the shift to cloud-based working for many companies, while service providers, both work-related and otherwise, also moved to Internet-based channels. Another big segment that did humongous amounts of online business was retail. All of these moves were positive for the industry (in terms of revenue) and partially offset the negative impact of declining business at brick-and-mortar players. At least some of the positives will outlive the pandemic. In other cases, the return to physical operations will be positive, as that segment returns to normal. Any improvement in the general level of economic growth will also improve prospects for the industry.   

 

  • The higher volume of business being operated through the cloud and the increasing demand for enabling software and services however involves infrastructure buildout, which increases costs for players. This causes great fluctuations in profitability as new infrastructure is depreciated and fresh debt is serviced. The pandemic exacerbated this situation leading to weak profitability in 2020 with 2021 growing off 2020 levels but not quite at 2019 levels yet.

 

  • The level of technology adoption by businesses and the proliferation of connected consumer devices that might help people connect and do business online also impacts growth. The high penetration of mobile devices among users and the pandemic-driven necessity is driving more businesses to adopt technology that they earlier stayed away from because of the cost involved.

Zacks Industry Rank Indicates A Recovery Is Underway

The Zacks Internet – Software & Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #95, which places it in the top 38% of more than 250 Zacks classified industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates that while the industry is recovering from pandemic-inflicted problems, certain issues remain.

Therefore, despite the industry’s positioning in the top 50% of Zacks-ranked industries, the earnings outlook for the constituent companies in aggregate continues to deteriorate. Looking at the aggregate estimate revisions, it appears that analyst confidence in the group’s earnings growth potential for 2021 has been on a more or less steady decline since last November. Over the past year, the 2021 average earnings estimate is down 63.2%. The estimate for 2022 is not much better, declining 42.3% from last November.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry’s Stock Market Performance Is Suffering

The past year’s performance of the Zacks Internet – Software & Services Industry shows that it has mostly lagged the broader Zacks Computer and Technology Sector, as well as the S&P 500. After briefly peaking in February, it fell sharply and the gap with both groups has widened since.

Aggregate share price of the industry appreciated a mere 2.6% over the past year compared to the broader sector’s increase of 32.6% and the S&P 500’s increase of 30.0%.

One-Year Price Performance

Zacks Investment ResearchImage Source: Zacks Investment Research

Industry’s Current Valuation

While many of the players are making losses at the moment, the industry as a whole continues to generate profits. So on the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at 77.57X, close to its highest multiple of 77.60X over the past year. The S&P 500’s P/E is 21.99X (at its median value). The industry is also overvalued compared to the sector’s forward-12-month P/E of 29.36X (at its highest point over the past year).

The industry has traded in the annual range of 57.71X to 77.60X, as the chart below shows.

Forward 12 Month Price-to-Earnings (P/E) Ratio

Zacks Investment ResearchImage Source: Zacks Investment Research

2 Stocks Worth A Closer Look

Donnelley Financial Solutions Inc.: Donnelley Financial provides software and services for content creation, management and distribution, as well as data analytics and multi-lingual localization services.

Continued strength in capital markets, client adoption of new recurring software products, strong demand for its Arc Digital and ActiveDisclosure compliance software, as well as for the its transactional software Venue. In addition, a stronger mix of software solutions continues to boost profitability.

This Zacks Rank #1 (Strong Buy) company is up 206.7% over the past year. The Zacks Consensus Estimate for the 2021 EPS increased $1.05 (25.8%) in the last 30 days. The estimate for 2022 increased $1.25 (28.2%).

Price and Consensus: DFIN

Zacks Investment ResearchImage Source: Zacks Investment Research

 

ChannelAdvisor (ECOM Free Report) : This provider of cloud-based e-commerce solutions and services including marketplaces, comparison shopping, paid search, social campaigns, flex feeds, web stores and rich media serves traditional retailers, online retailers, brand manufacturers and advertising agencies.

The company has benefited from investments facilitating the digital transformation of its brands, as well as its focus on product innovation, channel expansion and revenue retention. It also continues to expand its customer base, adding Master Lock, Detroit Diesel, Sennheiser, Xiaomi and Natural Balance Pet Foods in the last quarter.

This Zacks Rank #2 (Buy) company is up 82.1% over the past year. The Zacks Consensus Estimate for the 2021 EPS increased 8 cents (9.3%) in the last 30 days. The estimate for 2022 increased 7 cents (7.8%).

Price and Consensus: ECOM

Zacks Investment ResearchImage Source: Zacks Investment Research

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