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4 Stocks with Promise in the Recovering Internet Services Industry

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While the pandemic has not had the same effect on all players in the extremely diverse Internet – Services industry, 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 takes longer to recover from any drop in demand.

Because of the increased digitization and greater reliance on digital services over the past few months, a number of players have been able to recoup their losses to stage strong comebacks. Valuation hasn’t kept up in all cases.

Our picks are Etsy Inc, Internet Initiative Japan Inc., Cango Inc. and Crexendo Inc.

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), Facebook (FB - Free Report) , Baidu (BIDU - Free Report) and Akamai (AKAM) are some of the larger players in the space while Dropbox (DBX), Etsy (ETSY - Free Report) , Shopify (SHOP - Free Report) , ANGI Homeservices, Uber, Lyft and Trivago 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 negatively impacted. The situation could improve in the next few months as vaccines reach more people.

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 #151, which places it among the bottom 40% 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. However, its aggregate earnings estimate revisions for 2021 and 2022 are encouraging, with estimates jumping significantly in October before stabilizing in the next few months and then again in February to stabilize thereafter. The aggregate estimates for 2021 and 2022 are up an average 32.9% and 13.7%, respectively from last year.

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 moving more or less in line with 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.

The industry has soared 77.5% during this period compared to the broader sector’s 70.4% gain and the S&P 500 index’s 53.6% 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 30.11X multiple, which is relatively close to its median value of 29.76X over the past year indicating that there is further room for upside. However, the multiple is above the S&P 500’s 22.67X and the sector’s 27.87X, suggesting overvaluation.

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

4 Stocks With Promise

Etsy, Inc. (ETSY - Free Report) : Etsy sells around 85 million products through the Etsy.com and Reverb.com ecommerce marketplaces in the U.S., UK, Germany, Canada, Australia, France and India. It also offers other services including payments processing, advertising and shipping labels.

The pandemic has been a big boon to practically all ecommerce companies and ETSY is no different. Management is confident that the current momentum in the business can help drive the company toward its longer-term growth strategy of greater differentiation and competitiveness.

After a solid 80% beat in the December quarter, the current year EPS estimate of this Zacks Rank #1 stock increased 38.9% from $1.98 to $2.75.

The shares are up 348.2% over the past year.

Price and Consensus: ETSY

Internet Initiative Japan, Inc. (IIJIY - Free Report) : The company offers a comprehensive range of Internet access and other network services mainly to enterprise customers and also to other Internet service providers in Japan.

It is seeing very strong demand at enterprise customers that t expects will continue through the current year and beyond. This is allowing it to leverage its existing infrastructure to generate very strong double-digit growth in gross, operating and net profits. The strength in demand has encouraged management to raise the revenue and profit projections for 2021 as well.

So after solidly beating earnings estimates in the December quarter, the EPS estimate for the current year increased 25.8% from 66 cents to 83 cents.

The shares of this #1-ranked company are up 58.1% over the past year.

Price and Consensus: IIJIY

Cango Inc. ADR (CANG - Free Report) : The company provides an automotive transaction service platform connecting dealers, financial institutions, car buyers and other industry participants primarily in China.

The company is seeing strong growth in car sales, financing services and after-market sales/services, which management attributes to the company’s strong technological platform, focus on customer experience, vast dealership network and deep industry knowledge including supply chain issues.

CANG beat the Zacks Consensus Estimate by 14.2% in the last quarter, after which the current year EPS estimate increased 21.1% from 38 cents to 46 cents.

The shares of this Zacks Rank #2 company are up 65.0% over the past year.

Price and Consensus: CANG

Crexendo Inc. (CXDO - Free Report) : This is an ecommerce application service provider focused on cloud communications, Unified Communications as a Service (UCaaS), call center, collaboration services and other cloud-based business services that facilitate the provision of enterprise-class cloud services to businesses of all sizes.

The company is seeing relatively strong demand in its UCaaS business and profitability is now steady. Following an equity offering in Sep 2020 and a subsequent acquisition, management proceeded to build its sales teams. The company is now well positioned to generate strong organic growth even as it pursues accretive acquisitions.

The company’s December quarter earnings of 39 cents were way ahead of the the Zacks Consensus Estimate of a 2 cent EPS. However current-year estimates haven’t changed since.

The shares of this Zacks Rank #2 company have moved up 41.7% over the past year.

 Price and Consensus: CXDO

 

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