While the pandemic has not had the same effect on all players in the extremely diverse Internet – Services industry, it’s now clear that those players that were adversely impacted are also climbing out of the blues.
However, since this is a capital intensive industry with high fixed cost of operation and the fairly constant need to expand capacity, it’s harder to recover from any drop in demand.
Because of the increased digitization and greater reliance on digital services over the past few months, investors have bid up most stocks. So despite the growth prospects, most stocks look expensive. Our picks are The Trade Desk, Alphabet and Dropbox.
About The Industry
Internet – Services companies are primarily those that rely on huge software and hardware infrastructure, referred to as their properties, to deliver various services to consumers. Therefore, consumers can avail the services by accessing these properties with their personal connected devices from almost anywhere in the world.
Companies in the sector generally operate two models: an ad based model where the service is offered free and an ad free model where they charge for the service. Alphabet (GOOGL – Free Report) , Facebook (FB – Free Report) , Baidu (BIDU – Free Report) and Akamai (AKAM) are some of the larger players in the space while Dropbox (DBX – Free Report) , Etsy (ETSY – Free Report) , Shopify SHOP, ANGI Homeservices ANGI, Uber UBER, Lyft (LYFT – Free Report) and Trivago (TRVG – Free Report) are some of the emerging players.
COVID has brought mixed fortune for the industry because the wide range of services provided by this group has meant that some services were used more while others were used less. So things that helped people stay home for work, business or pleasure (as provided by companies like Etsy, Shopify, 21Vianet and CooTek) were positively affected, while those that depended on people moving out of their homes (as provided by companies like Uber and Lyft) or those that depended on strangers entering homes (as provided by ANGI Homeservices) were hit negatively. The situation is unlikely to change in the next few months given the new wave of infections and the time lag before vaccines reach the general public.
Factors Shaping The Industry
- Traffic acquisition is one of the most important drivers of revenue, so companies invest in advertising or building communities that can draw more users to their online properties and get them to spend more time there, much like a store owner would try to keep a prospective buyer within the store. Some large players, including those providing infrastructure services, grow by tying up with other such large players for access to their customers. Since the personal touch is absent in an online store, many rely on cookies and other technologies to track users, collect data on them and profile them in order to better understand their needs.
- As these companies have grown over time, some of them have collected such a wealth of information on their users that the data itself is now helping them build artificial intelligence (AI) to lower cost and generate new technologies and services. As a result, ad-based services are no longer considered free in some parts of the world and the EU in particular has framed a complex law in GDPR that requires service providers to acquire explicit permission from users before collecting their data.
- The installed base of connected devices continues to grow beyond PCs and smartphones to IoT, automotive and more, creating additional opportunities for targeting. The ownership of multiple devices automatically drives people to use these services more as they increasingly automate routine chores.
While not all businesses are built on the same scale or have the same customer reach, the scope for growth is huge. For companies that are already pursuing research in AI, the prospects are even brighter.
Zacks Industry Rank Indicates Uncertain Prospects
The Zacks Internet – Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #205, which places it among the bottom 19% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates near-term challenges.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 industry’s positioning in the bottom 50% of the Zacks-ranked industries is because of its relatively slow recovery from the pandemic. Looking at the aggregate earnings estimate revisions, we see that estimates have been rising since July although they still lag the year-ago number. So analysts appear cautious about the group’s earnings growth potential.
The industry’s earnings estimate for the current year is down 10.2% from November 2019. The average earnings estimate for 2021 is down 12.4%.
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 Leads on Stock Market Performance
While slightly lagging the broader Zacks Computer and Technology Sector through most of the past year, the Internet Services industry remains well ahead of the S&P 500 index as continued revenue growth (net of seasonal fluctuations) was hurt by the pandemic, re-igniting concerns related to the increasing cost of operation/expansion and rising debt levels.
The industry has soared 33.4% over this period compared to the S&P 500 index’s 15.3% gain and broader sector’s 35.2% gain.
One-Year Price Performance
Industry’s Current Valuation
On the basis of forward 12-month price-to-earnings (P/E) ratio, which is a commonly used multiple for valuing technology companies, we see that the industry is currently trading at a 29.75X multiple, which is close to its median value of 29.36X. However, the multiple is above the S&P 500’s 22.41X and the sector’s 26.81X, suggesting overvaluation.
Forward 12 Month Price-to-Earnings (P/E) Ratio
3 Stocks With Promise
The Trade Desk Inc. (TTD – Free Report) : The company provides a technology platform for ad buyers to create, manage and optimize data-driven digital advertising campaigns involving display, video, audio, native and social media across PCs, mobile devices and connected TV.
TTD is benefiting from the huge user shift to digital channels and limited budgets of advertisers. As advertisers look to maximize their ROI, as the data, platforms and volume of users surge, tools like the ones TTD offers are just what they need. This is driving results.
After a solid beat of over 159% in the last quarter, the current year EPS estimate of this Zacks Rank #2 stock increased 48.3% from $3.17 to $4.70.
The shares are up 235.1% over the past year and up 458.2% from their March lows.
Price and Consensus: TTD
Alphabet Inc. (GOOGL – Free Report) : Alphabet is primarily known for its search-engine although it has in the last few years branched into many other areas including cloud computing, mobile software and hardware, autonomous vehicles, ad-based video and music streaming, and healthcare.
The company is clearly firing on all cylinders as it is particularly well positioned to benefit from an at-home economy. With everyone operating from home, they are using YouTube more, companies are relying on Google Cloud more and advertisers are rushing to both search and YouTube because of the swelling traffic and the company’s AI-based tools. Google Play is of course a beneficiary as well.
So after solidly beating earnings estimates by 43.9%, the EPS estimate for the current year increased 13.5% from $44.92 to $50.97.
The shares of this #2-ranked company are up 35.3% over the past year and up 66.8% from their March lows.
Price and Consensus: GOOGL
Dropbox is focused on providing tools for distributed teams to function cohesively. Being a Virtual First company, the pandemic actually played to its strengths, pushing people to use its products and services more. With both individual and corporate investments adjusting to a more distributed remote-working paradigm, there’s unlikely to be a reverse trend in the foreseeable future. Therefore, this company looks really good.
The company beat the Zacks Consensus Estimate by 36.8% in the last quarter, after which current year estimates increased 14.3% from 77 cents to 88 cents.
The shares are up 2.2% over the past year and up 20.6% from their March lows.
Price and Consensus: DBX
5 Stocks Set to Double
Each was hand-picked by a Zacks expert as the #1 favorite stock to gain +100% or more in 2020. Each comes from a different sector and has unique qualities and catalysts that could fuel exceptional growth.
Most of the stocks in this report are flying under Wall Street radar, which provides a great opportunity to get in on the ground floor.
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