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Internet Content Stock Outlook: Regulations to Dull Growth

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The Zacks Internet – Content Industry comprises companies with diversified end-markets. The industry includes providers of video encoding platform, personal services, Internet content & information, staffing & outsourcing services, publishing, capital markets and media-based companies.

Moreover, apart from the United States, a number of companies in this industry are domiciled in the Netherlands, Israel, United Kingdom, Germany and China.

The Zacks Internet - Content industry is characterized by rapid technological change, frequent new product and service introductions, and evolving industry standards. However, the industry is susceptible to consumer spending trends. Moreover, industry participants are increasingly facing regulation particularly in China and the European Union (EU).

China has been very sensitive regarding Internet use over the years. The Chinese government has imposed significant restrictions on online search and other social-networking activities by blocking popular websites such as Twitter, YouTube and Facebook (FB - Free Report) .

It also has a number of regulations related to direct advertising in China, which is the major revenue source for these companies. On Jun 1, 2017, China implemented a tougher cyber security law which gives the government stronger control over online content.

Moreover, post Facebook’s Cambridge Analytica scandal that affected 87 million users, the industry participants have been facing rigorous scrutiny in the United States as well as the European Union (EU).

The implementation of General Data Protection Regulation (GDPR) that took effect from May 25 in the EU is already hurting industry participants. GDPR ensures that users know, understand, and consent to the data collected about them.

Internet companies have to keep consumers informed about why the data is being collected and whether it will be used to create profiles of people’s actions and habits.

Moreover, the latest EU Copyright Directive aims at charging U.S. Internet giants for using content from news outlets as well as to use filters and prevent uploading of content that is copyrighted.

Further, regulations to curb terrorist and extremist content are expected to be implemented within a short-span of time in the EU region. Reportedly, if companies fail to remove such content they could face sanctions.

Industry Lags on Shareholder Returns

Looking at shareholder returns over the past year, it appears that a tough operating environment has been hurting investor sentiments in the Internet - Content industry’s growth prospects.

The Zacks Internet - Content Industry, within the broader Zacks Computer And Technology Sector, has underperformed both the S&P 500 and its own sector over the past year.

While the stocks in this industry have collectively lost 16.6%, the Zacks S&P 500 Composite and Zacks Computer And Technology Sector have rallied 16.3% and 17.6%, respectively.

One-Year Price Performance


 

Stretched Valuation a Concern

The Zacks Internet - Content industry primarily comprises growth companies that are investing heavily in research & development (R&D) to boost top line.

So, one might get a good sense of the industry’s relative valuation by looking at its price-to-sales ratio (P/S), which reflects how much investors are paying for each dollar of revenues generated by the company.

Valuation of the Internet - Content industry looks stretched at the moment. It currently has a trailing 12-month P/S ratio of 4.03, which is close to the high of 6.52 in the past year.

The space also looks expensive when compared with the market at large as the trailing 12-month P/S ratio for the S&P 500 is 3.47.

Price-to-Sales Ratio (TTM)


 

Moreover, a comparison of the group’s P/S ratio with that of its broader sector ensures that the Zacks Internet - Content industry is trading at a significant premium. The Zacks Computer and Technology Sector’s trailing 12-month P/S ratio of 3.64 is below the group’s ratio.

Price-to-Sales Ratio (TTM)


 

Underperformance May Continue Due to Dim Earnings Outlook

The heightened regulatory activities and increasing foreign exchange volatility are expected to hurt shareholder returns in the near term.

However, what really matters to investors is whether this group has the potential to perform 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 its earnings outlook. Empirical research shows that earnings outlook for the 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 it and the industry's aggregate stock market performance.

Price and Consensus: Zacks Internet - Content 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 $1.20 EPS estimate for the industry for 2018 is not the actual bottom-up EPS estimate for every company in the Zacks Internet - Content industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the EPS of the industry for 2018, but how this projection has evolved recently.

Current Fiscal Year EPS Estimate Revisions


 

As you can see here, the $1.20 EPS estimate for 2018 has declined from $1.34 at the end of July. In other words, the sell-side analysts covering the companies in the Zacks Internet - Content industry have been pessimistic about raising their estimates.

Zacks Industry Rank Blurs Prospects

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

The Zacks Internet-Content industry currently carries a Zacks Industry Rank #196, which places it at the bottom 23% of the 256 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.

Long-Term Growth Prospects Strong

The long-term (3-5 years) EPS growth estimate for the Zacks Internet - Content industry appears promising. The group’s current level of 11.75% is better than 9.8% for the Zacks S&P 500 composite.

Mean Estimate of Long-Term EPS Growth Rate


 

The Zacks Internet Content industry’s long-term growth prospects are alluring. Expanding mobile and cloud-based offerings by industry participants is a major growth driver. Moreover, proliferation of smart devices and increasing automation of the application development process bode well for the industry.

These factors are expected to drive top-line growth that has gained significant momentum since the end of 2014.


 

Moreover, another indication of solid long-term prospects is the improvement in the group’s gross margin.


 

However, a surging debt level remains a concern for industry participants.



 

Bottom Line

A slow market growth rate and regulatory concerns in China and the EU could weigh on the near term prospects of the Internet - Content industry. Below are two stocks that carry a bearish Zacks Rank that we would recommend investors to stay away from for the time being.

YY Inc. (YY - Free Report) : Guangazhou, China-based YY carries a Zacks Rank #4 (Sell). The stock has lost 6.1% over the past year. The consensus EPS estimate for the company has moved 6.8% lower for the current year, over the last 60 days.

Price and Consensus: YY


 

Sina Corporation (SINA - Free Report) : Shanghai, China-based Sina carries a Zacks Rank #5 (Strong Sell). The stock has lost a massive 43.1% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 4.8% downward over the last 60 days.

Price and Consensus: SINA


 

However, TechTarget (TTGT - Free Report) is a stock that investors can pick to gain a footing in this industry. The stock has a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

TechTarget has returned 91.5% in the past year. The Zacks Consensus Estimate for the current-year EPS has been revised upward by a penny over the last 60 days.

Price and Consensus : TTGT

 

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