Not All Internet Stocks Are Attractive

Internet Company Earnings Have Been Mixed

The most important thing I look for when analyzing an industry is a discernable business trend. I want to find the factors that are driving earnings estimates higher or lower.

Unfortunately, such trends don't always exist. This is the case with Internet stocks.

On the surface, Electronic Commerce and Internet Services look good with Zacks Industry Ranks of 2.86 and 2.67, respectively. These strong ranks reflect the fact that both groups have more positive estimate revisions than negative revisions.

Beneath the surface, however, the waters are not completely calm. Not quite a case of the good, the bad and the ugly, but more of the good and the not-so good.

The Good

There are 5 companies that account for more than half of all the positive revisions within the 2 groups: Amazon.com (AMZN - Analyst Report), CyberSource Corporation (CYBS - Snapshot Report), Equinix Inc. (EQIX - Analyst Report), Google, Inc. (GOOG - Analyst Report) and Netflix, Inc. (NFLX - Snapshot Report).

AMZN, EQIX, GOOG and NFLX all topped first-quarter earnings estimates, and CYBS matched. More importantly, brokerage analysts raised their full-year forecasts on all 5 companies following their recent reports.

There were good reasons for the optimism:

• AMZN saw sales rise, despite the recession. Its Q1 margins also widened.
• CBYS delivered a double-digit increase in revenues and processed a record number of transactions.
• EQIX said revenues rose both on a year-over-year and a sequential basis
• GOOG reported an increase in aggregate paid clicks, a sign that the company is remaining the dominant player in search-term advertising
• NFLX is still seeing growth in its subscriber count and raised its full-year EPS guidance.

NFLX is a Zacks #1 Rank ("strong buy") stock. AMZN, CYBS and EQIX are Zacks #2 Rank ("buy") stocks. GOOG changed this morning from a Zacks #2 Rank stock to a Zacks #3 Rank ("hold") stock.

The Not So Good

On the other side are companies like eBay Inc. (EBAY - Analyst Report) and Yahoo! Inc. (YHOO - Analyst Report).

The reaction to these companies' earnings reports has been decidedly mixed with approximately an equal number of analysts raising and cutting their full-year forecasts.

Net revenues for EBAY fell 8%. The decline was led by weakness in the company's marketplace segment, which includes the well-known auction web site. Margins also contracted.

Yahoo also saw revenues and profits fall. Declines in both display and search advertising hurt the company. (Though Google saw an increase in paid clicks, there was downward pressure on advertising prices.)

Both EBAY and YHOO are Zacks #3 Rank ("hold") stocks.

Be Selective

Though some of the reports were good, not all of the companies are enjoying positive business momentum. This is worrisome given the rally in Internet stocks.

Since early-March, First Trust Dow Jones Internet Index Fund (FDN) has soared by more than 30%. The magnitude of the rally over such a short period of time should be enough to give investors pause. The mixed reaction to first-quarter reports only adds to the probability that there isn't much short-term upside for some Internet stocks.

Certainly, there are opportunities in individual stocks - we hold NFLX in the Zacks Elite Focus List portfolio - but just not for the group as a whole, at least over the short-term.

Zacks Premium and Zacks Elite subscribers can view the Zacks Industry Rank List at http://www.zacks.com/zrank/zrank_inds.php. This interactive list allows you to see all of the companies, and their Zacks Rank, within more than 200 industries. Shown below is the Zacks Sector Rank List, which shows the trend in estimate revisions on a broader scale.

Charles Rotblut, CFA, is the senior market analyst for Zacks.com. He can be reached at crotblut@zacks.com.