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3 Picks from the Attractive Internet Services Industry
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Macro factors currently driving the economy, such as inflation, rate hikes, supply chain issues (though minimal right now and in pockets), the relative strength in labor and so forth have a varied impact on players in the extremely diverse Internet – Services industry.
Since this is a capital-intensive industry with high fixed cost of operation and the fairly constant need to expand capacity, a high interest rate just isn’t very positive for it. Nor is the impending recession, or at least slowdown, since the industry tends to do better when the overall economy does well.
As a result, steadying interest rates and evidence of the economy holding up better than expected are helping drive sentiments. While infrastructure investments may be continuing at a moderate pace, innovation remains the key mantra for these players and these actions are being buttressed with cost control measures and/or the maintenance of good operational efficiency. Valuations continue to drop, creating opportunities.
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. People 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 the service is charged. Alphabet, Baidu and Akamai are some of the larger players while Dropbox, Etsy, Shopify, Uber, Lyft and Trivago are some of the emerging players.
Because of the diversity of services offered, it is difficult to identify industrywide factors that could affect all players. Macro factors such as inflation, rate hikes, supply chain issues and so forth affect differently.
Factors Shaping the Industry
It goes without saying that increased digitization of different aspects of daily life is a driver for the entire industry, because digitization essentially transfers work online, which is where Internet service providers are required. To that extent, the pandemic has proved course-altering for the industry because of the huge volume of transactions that moved online. And people are not giving up all of these conveniences to go back to their old ways. The expansion of the installed base of connected devices beyond PCs and smartphones to IoT, automotive and more is creating additional opportunities for targeting. The ownership of multiple devices automatically drives people to use these services more as they increasingly automate routine chores.
Being a capital-intensive industry, there is the need to raise funds to build out costly infrastructure. Funds are also needed to maintain this infrastructure. Capitalspending continues to trend higher despite high interest rates and a possible recession, which if it happens in 2024, will impact revenue growth and, therefore, cost absorption. Companies are, however, trying to manage cost in case demand softens.
Debt levels have been relatively steady this year, coming down slightly in the March quarter, as Alphabet’s debt levels were lowered. Two things typically trigger major increases in debt levels (and the two are not mutually exclusive): fixed asset investment and acquisitions. The 2023 capital spending trend looks non-exceptional. Following the seasonal dip in December, March and June followed patterns in earlier years. The appetite for acquisitions appears to be low, however, as seen from the aggregated intangibles balance. Alphabet, for which swallowing smaller players is all in the day’s work, also appears to be going slow this year.
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 attract and then 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 analyze 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 generate revenues from new technologies and services and also lower the cost of operation. Ad-based services are no longer considered free. The EU’s GDPR and the CCPA (California Consumer Privacy Act) for example require service providers to acquire explicit permission from users before collecting their data. While not all businesses are built on the same scale or have the same customer reach, AI tools are increasingly helping organizations of every size thus increasing demand for companies providing them.
Zacks Industry Rank Remains Positive
The Zacks Internet - Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #55, which places it among the top 22% of more than 250 Zacks-classified industries.
The group’s Zacks Industry Rank, which is basically the average rank of all the member stocks, indicates that there are several opportunities in the space. However, the diverse range of companies makes stock selection tricky.
Looking at the aggregate earnings estimate revisions over the past year, we see steady increases, particularly from July 2023. Overall, the industry’s earnings estimate for 2023 is up 17.1% from Jan 2023 and the estimate for 2024 is up 14.3% from Jan 2023.
Historically, the top 50% of Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1. So the industry’s positioning in the top 50% of the Zacks-ranked industries should be considered a positive, even if a recession, albeit a shallow one upsets current momentum.
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 initially trading more or less in line with the broader Technology sector and the S&P 500, the industry pulled ahead in May. Since then, it has at times traded in line with the broader industry, although consistently at a premium to the S&P 500. Despite the dip in October (likely related to uncertainty about another rate hike, increasing costs for the company), the overall trajectory remained upward.
Overall, the industry gained a net 55.8% in the past year while the broader sector gained 45.5% and the S&P 500 20.9%.
One-Year Price Performance
Image Source: Zacks Investment Research
Industry's Current Valuation
On the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at a 22.36X multiple, which is at a slight premium to its median value of 21.48X over the past year. Although a premium to the S&P 500’s 20.02X it is still a discount to the sector’s 24.92X.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
3 Solid Bets
Given the attractiveness of the sector, there are many possible choices. The first two selected today carry a Zacks #1 (Strong Buy) rank while the third is rated Buy (Zacks Rank #2).
Shopify Inc. (SHOP): Ottawa, Canada-based Shopify offers a platform facilitating a whole range of ecommerce operations across Canada, the U.S., the Middle East, Africa, the Asia Pacific and Latin America. The platform allows merchants to display, market and sell products using web and mobile storefronts, physical retail locations, pop-up shops, social media storefronts, native mobile apps, buy buttons and marketplaces. It also enables product sourcing, inventory management, order processing and fulfilment, customer acquisition and relationship building, access to finance, cash, payments and transaction management, and reporting. The company also offers analytics.
In the September quarter, Shopify posted a huge earnings surprise of 183.3% on revenue that surprised by a little less than 3%. In the last 60 days, estimates for 2023 and 2024 have increased a couple of cents each. SHOP estimates for 2023 and 2024 have increased 143.8% and 855.6% in the past year. Analysts currently expect 2023 revenue and earnings growth of 24.7% and 1,650%, respectively. For 2024, they’re expecting 19% revenue growth and 48.1% earnings growth.
The shares are up 103.4% over the past year.
Price and Consensus: SHOP
Image Source: Zacks Investment Research
Upwork Inc. (UPWK - Free Report) : San Francisco, California-based Upwork is a work marketplace connecting professionals in sales and marketing, customer service, data science and analytics, design and creative, web, mobile, and software development, as well as agencies with businesses in the U.S., India, Philippines and elsewhere. Its workflow management services also facilitate various business operations.
Upwork’s business model benefits from the hybrid and work-from-home models. However, recent revenue momentum is attributable to its AI focus, where it is increasingly involved in bringing AI-enabled experiences, talent and work to clients. It is also entering into partnerships to deliver differentiated tools to customers. Management has said that enhancements to its AI Services hub has led to a ten-fold increase in average monthly visitors since its launch in the second quarter. The addition of generative AI apps in particular are expected to be a big draw for customers. Improved efficiency, effectiveness and matching speed also attract customers. Some of the new client wins include Dropbox, IT’SUGAR, Moderna and Florida State University. Overall, in the third quarter, the number of enterprise clients spending $5 million or more in the trailing twelve months rose 43%. Upwork also has cost optimization programs underway. These are driving unit cost improvements and thereby, profitability.
The earnings surprise in the September quarter was a whopping 500%. What’s more it came on top of a very attractive revenue surprise of around 4%. The last 60 days have seen no change in the 2023 estimate although there was a 2-cent increase in the 2024 estimate. Its 2023 and 2024 earnings estimates have increased a respective 108.8% and 221.4% in the past year. At current levels, top line estimates represent 10.6% growth in 2023 (over 2022 levels) followed by 12.1% growth in 2024. Bottom line estimates represent 900% improvement in 2023 and 43.8% improvement in 2024.
UPWK shares have appreciated 17.1% over the past year.
Price and Consensus: UPWK
Image Source: Zacks Investment Research
Uber Technologies, Inc. (UBER - Free Report) : San Francisco, California-based Uber develops and operates proprietary technology applications in the U.S., Canada, Latin America, Europe, the Middle East, Africa, and Asia excluding China and Southeast Asia. The primary services offered include ride sharing, grocery delivery, freight and advertising.
In the September quarter, Uber missed on the bottom line by 32.4% and on the top line by 1.8%. However, the Zacks Consensus Estimate for 2023 has itself jumped 177.1% since last January while the estimate for 2024 jumped 111.5%. Therefore, random misses are not a catastrophe. As things stand now, analysts are projecting revenue and earnings increases of a respective 16.4% and 108% for 2023 and 15.6% and 195.5% for 2024. The estimates are unchanged in the last 60 days.
UBER shares have appreciated 118.0% over the past year.
Price and Consensus: UBER
Image Source: Zacks Investment Research
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3 Picks from the Attractive Internet Services Industry
Macro factors currently driving the economy, such as inflation, rate hikes, supply chain issues (though minimal right now and in pockets), the relative strength in labor and so forth have a varied impact on players in the extremely diverse Internet – Services industry.
Since this is a capital-intensive industry with high fixed cost of operation and the fairly constant need to expand capacity, a high interest rate just isn’t very positive for it. Nor is the impending recession, or at least slowdown, since the industry tends to do better when the overall economy does well.
As a result, steadying interest rates and evidence of the economy holding up better than expected are helping drive sentiments. While infrastructure investments may be continuing at a moderate pace, innovation remains the key mantra for these players and these actions are being buttressed with cost control measures and/or the maintenance of good operational efficiency. Valuations continue to drop, creating opportunities.
Our picks are Shopify (SHOP), Upwork (UPWK - Free Report) and Uber (UBER - Free Report) .
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. People 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 the service is charged. Alphabet, Baidu and Akamai are some of the larger players while Dropbox, Etsy, Shopify, Uber, Lyft and Trivago are some of the emerging players.
Because of the diversity of services offered, it is difficult to identify industrywide factors that could affect all players. Macro factors such as inflation, rate hikes, supply chain issues and so forth affect differently.
Factors Shaping the Industry
Zacks Industry Rank Remains Positive
The Zacks Internet - Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #55, which places it among the top 22% of more than 250 Zacks-classified industries.
The group’s Zacks Industry Rank, which is basically the average rank of all the member stocks, indicates that there are several opportunities in the space. However, the diverse range of companies makes stock selection tricky.
Looking at the aggregate earnings estimate revisions over the past year, we see steady increases, particularly from July 2023. Overall, the industry’s earnings estimate for 2023 is up 17.1% from Jan 2023 and the estimate for 2024 is up 14.3% from Jan 2023.
Historically, the top 50% of Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1. So the industry’s positioning in the top 50% of the Zacks-ranked industries should be considered a positive, even if a recession, albeit a shallow one upsets current momentum.
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 initially trading more or less in line with the broader Technology sector and the S&P 500, the industry pulled ahead in May. Since then, it has at times traded in line with the broader industry, although consistently at a premium to the S&P 500. Despite the dip in October (likely related to uncertainty about another rate hike, increasing costs for the company), the overall trajectory remained upward.
Overall, the industry gained a net 55.8% in the past year while the broader sector gained 45.5% and the S&P 500 20.9%.
One-Year Price Performance
Image Source: Zacks Investment Research
Industry's Current Valuation
On the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at a 22.36X multiple, which is at a slight premium to its median value of 21.48X over the past year. Although a premium to the S&P 500’s 20.02X it is still a discount to the sector’s 24.92X.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
3 Solid Bets
Given the attractiveness of the sector, there are many possible choices. The first two selected today carry a Zacks #1 (Strong Buy) rank while the third is rated Buy (Zacks Rank #2).
Shopify Inc. (SHOP): Ottawa, Canada-based Shopify offers a platform facilitating a whole range of ecommerce operations across Canada, the U.S., the Middle East, Africa, the Asia Pacific and Latin America. The platform allows merchants to display, market and sell products using web and mobile storefronts, physical retail locations, pop-up shops, social media storefronts, native mobile apps, buy buttons and marketplaces. It also enables product sourcing, inventory management, order processing and fulfilment, customer acquisition and relationship building, access to finance, cash, payments and transaction management, and reporting. The company also offers analytics.
In the September quarter, Shopify posted a huge earnings surprise of 183.3% on revenue that surprised by a little less than 3%. In the last 60 days, estimates for 2023 and 2024 have increased a couple of cents each. SHOP estimates for 2023 and 2024 have increased 143.8% and 855.6% in the past year. Analysts currently expect 2023 revenue and earnings growth of 24.7% and 1,650%, respectively. For 2024, they’re expecting 19% revenue growth and 48.1% earnings growth.
The shares are up 103.4% over the past year.
Price and Consensus: SHOP
Image Source: Zacks Investment Research
Upwork Inc. (UPWK - Free Report) : San Francisco, California-based Upwork is a work marketplace connecting professionals in sales and marketing, customer service, data science and analytics, design and creative, web, mobile, and software development, as well as agencies with businesses in the U.S., India, Philippines and elsewhere. Its workflow management services also facilitate various business operations.
Upwork’s business model benefits from the hybrid and work-from-home models. However, recent revenue momentum is attributable to its AI focus, where it is increasingly involved in bringing AI-enabled experiences, talent and work to clients. It is also entering into partnerships to deliver differentiated tools to customers. Management has said that enhancements to its AI Services hub has led to a ten-fold increase in average monthly visitors since its launch in the second quarter. The addition of generative AI apps in particular are expected to be a big draw for customers. Improved efficiency, effectiveness and matching speed also attract customers. Some of the new client wins include Dropbox, IT’SUGAR, Moderna and Florida State University. Overall, in the third quarter, the number of enterprise clients spending $5 million or more in the trailing twelve months rose 43%. Upwork also has cost optimization programs underway. These are driving unit cost improvements and thereby, profitability.
The earnings surprise in the September quarter was a whopping 500%. What’s more it came on top of a very attractive revenue surprise of around 4%. The last 60 days have seen no change in the 2023 estimate although there was a 2-cent increase in the 2024 estimate. Its 2023 and 2024 earnings estimates have increased a respective 108.8% and 221.4% in the past year. At current levels, top line estimates represent 10.6% growth in 2023 (over 2022 levels) followed by 12.1% growth in 2024. Bottom line estimates represent 900% improvement in 2023 and 43.8% improvement in 2024.
UPWK shares have appreciated 17.1% over the past year.
Price and Consensus: UPWK
Image Source: Zacks Investment Research
In the September quarter, Uber missed on the bottom line by 32.4% and on the top line by 1.8%. However, the Zacks Consensus Estimate for 2023 has itself jumped 177.1% since last January while the estimate for 2024 jumped 111.5%. Therefore, random misses are not a catastrophe. As things stand now, analysts are projecting revenue and earnings increases of a respective 16.4% and 108% for 2023 and 15.6% and 195.5% for 2024. The estimates are unchanged in the last 60 days.
UBER shares have appreciated 118.0% over the past year.
Price and Consensus: UBER
Image Source: Zacks Investment Research