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E-Commerce Outlook: Numbers Indicate Limited Upside

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Electronic-commerce, the method of buying and selling goods and services via a software platform, continues to evolve as the technologies driving it get more advanced.

On the one side are user devices, which are getting bigger, brighter and more capable. Voice-controlled devices like Amazon Echos, Google Homes and Apple HomePods are facilitating conversational commerce.

On the other side are the software platforms facilitating the transaction, which are getting AI-enabled and more sophisticated, and therefore, more capable of delivering a satisfying user experience. Social networks have started playing a bigger role today, with chatbots facilitating back end operations and customer care.

But both ecommerce pure-plays and traditional retailers branching into ecommerce realize the importance of physical presence because it is only proximity to a consumer that can facilitate quick delivery. Self-driven delivery vehicles and drones are already on the horizon to deal with logistics problems and make deliveries smoother still.  

Another factor to keep in mind is Amazon’s complete dominance in the U.S. and its growing presence in other important markets. This is driving some traditional players to partner with Amazon and the stronger players to partner with Google to fill technology gaps.

Industry Leads on Shareholder Returns

The Zacks Electronic - Commerce Industry, which is a 26-stock group within the broader Zacks Retail And Wholesale Sector, has outperformed both the S&P 500 and its own sector over the past year.

So we see that the stocks in this industry have collectively gained 40.4% over the past year, while the Zacks S&P 500 Composite and Zacks Retail and Wholesale Sector have rallied 13.8% and 27.6%, respectively.

The industry displays a unique risk-return scenario because of the outsized positive impact of mainly Amazon and a few other players like TripAdvisor, IAC Interactive and Groupon. This has been impacted by underperformance of other big players like Expedia, JD, eBay and Alibaba.

One-Year Price Performance

 

Electronic-Commerce Stocks Look Expensive

The strong run in share prices over the past year have, however, led to a relatively rich valuation.

It makes sense to value the industry based on earnings, growth prospects and cash flow because solid revenue growth opportunity goes hand in hand with huge running costs in things like R&D, intellectual property creation, marketing expenses, as well as technology and other investments.

The industry currently has a price to forward 12 months’ earnings ratio of 48.4X, which is below the annual high of 53.5X but at the median level, suggesting that upside if any will be limited. Comparing this with the S&P 500, we see that it is way ahead of the S&P 500’s 17.2X (median 18.3X). 

 

 

Same is the case when comparing with the sector’s 24.2X.

 

The industry currently has a price to forward earnings growth ratio of 2.3X, which is below the highest level of 2.7X and median level of 2.4X over the past year, suggesting limited upside. Comparing this with the S&P 500, we see that it is ahead of the S&P 500’s 1.7X (median 1.8X). 

 

It is also ahead of the sector’s 1.7X.

 

The industry currently has a price to free cash flow ratio of 36.5X, which while being somewhat lower than the highest level of 45.6X over the past year, is just over the median level of 36.3X. This seems to indicate that upside if any will be limited. Comparing this with the S&P 500, we see that it is ahead of the S&P 500’s 23.0X. 

 

It is also ahead of the sector’s 19.4X.

 

All three measures indicate that the industry is overvalued and that upside if any will be limited.

Solid Growth Potential Won’t Offset Rich Valuation

Revenue growth rates may be expected to remain very strong as a result of more companies moving online and existing players utilizing more advanced tools and analytics to increase their return on investment.

Differentiation in the business comes from better technology for easier navigation and payment, speedier delivery and returns, brand building, comparison shopping, loyalty and so forth. So larger players are relatively better positioned for growth. At the same time, there is fierce price competition, which keeps prices down.

Margins are also pressured by the need to build out infrastructure to support the strong revenue growth.

So while the above ratio analysis shows that investors are upbeat about the solid prospects, the real question for them is whether this group has the potential to continue performing better than the broader market in the quarters ahead.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is the industry's earnings outlook. Empirical research shows that the earnings outlook for an industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

Price and Consensus: Electronic-Commerce Industry

 

This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the $3.42 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Electronic-Commerce industry, but rather an illustrative aggregate number created by our proprietary analytics model. So the key factor to keep in mind is not the dollar earnings of $3.42 'per share' of the industry for 2018, but how this dollar number has evolved recently.

So looking at the aggregate earnings estimate revisions, it appears that analysts have turned cautious about this group’s earnings potential.

The consensus EPS estimate for the current fiscal year is up 4.3% since January, but down 3.7% over the past month.

Current Fiscal Year EPS Estimate Revisions

 

Zacks Industry Rank Indicates Weak Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates underperformance in the near term.

The Zacks Electronic-Commerce industry currently carries a Zacks Industry Rank #188, which places it at the bottom 27% of more than 250 Zacks 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.

Our proprietary Heat Map shows intermittent deterioration the industry’s rank in four out of the last seven weeks.

 

Electronic-Commerce Stocks Promise Long-Term Growth

While the near-term prospects look uncertain for investors, the long-term (3-5 years) EPS growth estimate for the Zacks Electronic-Commerce industry appears attractive. That’s because more business is moving online as we speak from both existing and new players. New technology is also being introduced, existing tools fine-tuned and artificial intelligence is increasingly being employed to facilitate doing more business online.

So it isn’t surprising that the group’s mean estimate of long-term EPS growth rate of 20.7% compares favorably with the 9.8% growth for the Zacks S&P 500 composite.

Mean Estimate of Long-Term EPS Growth Rate

 

The long-term growth is a continuation of strong performance over the past few years. Take revenue for example, which has gained momentum since 2012.

 

The EBIT fluctuated more because of increased operating expenses particularly in 2015, but shows an attractive upward trend since then.

 

A significant increase in share count in 2014 impacted per share metrics rendering some measures less meaningful. But a quick look at the balance sheet indicates notable increases in intangibles, cash and investments on the one side and long term debt on the other. In fact, the debt equity ratio has increased substantially from around 30% in 2013 to 42% last year. While still reasonable, it’s worth keeping in mind that the strong growth comes at a price.

 

Bottom Line

This is a place to avoid right now except for long-term plays, especially considering the rich valuation. This is seen in the relatively small number of buy-ranked stocks in the industry (Zacks Ranks #1 and #2). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

So while most of us would do better to avoid the industry, here are some stock picks for those with a longer investment horizon-

Groupon Inc (GRPN - Free Report) : The Zacks Rank #1 stock has gained 28.0% over the past year. The Zacks Consensus Estimate for the current-year EPS is unchanged in the last 60 days.

Price and Consensus: GRPN

 

IAC/Interactive Corp. (IAC - Free Report) : The Zacks Rank #1 stock has gained 44.6% over the past year. The Zacks Consensus Estimate for the current-year EPS is down 8.9% in the last 60 days and up 10.3% in the last 30 days.

Price and Consensus: IAC

 

TripAdvisor Inc. (TRIP - Free Report) : The Zacks Rank #1 stock has gained 61.8% over the past year. The Zacks Consensus Estimate for the current-year EPS is down 0.7% in the last 60 days.

Price and Consensus: TRIP

 

Amazon.com Inc (AMZN - Free Report) : The Zacks Rank #2 stock has gained 73.5% over the past year. The Zacks Consensus Estimate for the current-year EPS is down 0.4% in the last 60 days.

Price and Consensus: AMZN

 

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