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3 Stocks to Buy in Internet Software & Services

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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. But there are a number of companies here that were in fact 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 next year or two. However, the significant decline in overall business levels are playing spoiler. As such, it makes sense to dig deeper to find individual stocks with strong outlooks because chances are they will have an attractive valuation. This search exposed Criteo (CRTO - Free Report) , Momo Inc (MOMO - Free Report) and Globant S.A (GLOB - Free Report) that look like good investments right now.

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 business online 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 gradual. But 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 has exacerbated this situation. The net cash per share, which has been moving up over the past three years took a dip in the last quarter as receivables jumped, although it didn’t go below the pre-pandemic level.

 

  • 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 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 Uncertain Prospects

The Zacks Internet – Software & Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #229, which places it in the bottom 10% of more than 250 Zacks classified industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates that there are issues with the industry’s near-term prospects. 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 a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate negative estimate revisions, it appears that analyst confidence in the group’s earnings growth potential for 2021 has been on a steady decline since last July. Over the past year, the 2021 average earnings estimate is down 31.7%. The estimate for 2022 is down 43.0%.

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 Impressive

The past year’s performance of the Zacks Internet – Software & Services Industry shows a neck-to-neck race with the broader Zacks Computer and Technology Sector, both of which have performed better than the S&P 500 index.

Aggregate share price of the industry appreciated 52.1% over the past year compared to the broader sector’s increase of 53.5% and the S&P 500’s 36.8%.

One-Year Price Performance

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, which is a commonly used multiple for valuing Internet companies, we see that the industry is currently trading at 66.1X (close to its 52-week high) compared to the S&P 500’s 21.2X (lower than its median value). It is also overvalued compared to the sector’s forward-12-month P/E of 26.8X.

The shares have traded in the annual range of 36.2X to 67.2X, as the chart below shows.

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

 

3 Stocks with Promise

Criteo S.A.: This provider of ad tech solutions has access to 20,000+ advertisers across 100 countries on the one side, and customer data relating to $2 billion worth of daily online sales and 4 billion product SKUs on the other.

The company is poised to gain from the massive push toward ecommerce in recent years. While the pandemic impacted advertiser budgets and limited spending, with a corresponding negative impact on the company’s results, it’s encouraging to note that business is coming back strongly and CRTO has also started seeing large multi-year deals. With the ecommerce opportunity expected to go from 16% of total sales today to 23% by 2023, Criteo, with its ability to provide marketing insights and yield gains, should see steady growth.

This Zacks Rank #1 company is up 250.3% over the past year. The Zacks Consensus Estimate for the 2021 EPS increased 46 cents (28.0%) in the last thirty days. The estimate for 2022 also jumped 45 cents (27.4%).

Price and Consensus: CRTO

Momo Inc.: Momo provides a mobile-based social networking platform often used as an online dating site, primarily in the Peoples Republic of China. Its platform includes mobile applications and related features, functionalities, tools and services. Additionally, it offers exclusive and non-exclusive mobile game services and other services like paid emoticons and mobile marketing. It also offers a membership subscription.

The company has had a hard time in 2020 because of the pandemic and also because of internal reorganization of its live video streaming business (its biggest segment) to increase focus on long-tail content. Management continues to take a conservative stance about near-term results because of COVID impacts.

As a result, the Zacks Rank #2 company has lost 37.8% of its value over the past year.

However, the worst may be over now because the Zacks Consensus Estimate for 2021 currently points to 3.7% revenue growth and a 1.3% decline in earnings. Moreover, estimates have moved up slightly in the last 7 days and there should be further revisions once the company reports later this month.

Price and Consensus: MOMO

Globant S.A.: Luxembourg-based Globant is a digitally native technology services company offering engineering, design and innovation services, including content management systems and e-commerce applications. It sells data management, quality assurance, mobile testing, test automation, load and performance testing, and game testing services. It provides various software solutions primarily in North America, Europe, Latin America and other regions.

The rapid digitization of the global economy and increasing use of new technologies like AR and VR plays to the company’s sweet spot. So it is positioned to grow strongly for years to come. It comes as no surprise then that recent results have been very strong.

This Zacks Rank #3 company is also seeing positive estimate revisions (2021 earnings estimate up 4.8% in the last 30 days, 2022 estimate up 3.9%). Moreover, revenue is currently expected to grow 30.7% this year and 20.9% in the next. Earnings are expected to grow 33.5% in 2021 and 21.2% next year.

Despite the strong outlook, shares dropped 37.8% over the past year, resulting in an attractive valuation.

Price and Consensus: GLOB

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Criteo S.A. (CRTO) - free report >>

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