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Internet Services Industry Outlook: Opportunities Abound In This Undervalued Segment

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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. 

Here are the three major themes in 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. 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 Bright Prospects

The Zacks Internet - Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #54, which places it among the top 21% 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 bright 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 top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gaining confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimate for the current year is up 4.8%.

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 Lags on Stock Market Performance

The Zacks Internet – Services Industry has lagged the broader Zacks Computer and Technology Sector as well as the S&P 500 index over the past year as regulatory concerns involving some of the largest players are weighing on sentiments.

The industry has declined 15.2% over this period compared to the S&P 500 index’s 5.8% gain and broader sector’s 1.6% 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 21.96X compared to the S&P 500’s 16.84X. It is also above the sector’s forward-12-month P/E of 19.25X.

In fact, the industry is currently trading at the low end of its annual range of 34.44X to 21.96X and therefore, also below the median of 29.52X, as the chart below shows.

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

Bottom Line

The main reason for the continued negativity in sentiment is the regulatory overhang on some of the leading players. This has broadly depressed prices, despite the fact that the constituent companies have solid growth prospects. Another positive is the fact that estimates are now moving up.

A number of companies present solid growth opportunity here and a few with Zacks #1 Rank (Strong Buy) and #2 Rank (Buy) are highlighted below. You can see the complete list of today’s Zacks #1 Rank stocks here.

Autohome Inc. (ATHM - Free Report) : This online travel agency has lost 19.4% in the past year. The current fiscal Zacks Consensus EPS Estimate for this Zacks Rank #1 company remains unchanged in the last 7 days.

Price and Consensus: ATHM

Marchex Inc. (MCHX - Free Report) : This web-based search and other services company has gained 40.7% in the past year. The current fiscal Zacks Consensus EPS Estimate for this Zacks Rank #2 remains unchanged in the last 30 days.

Price and Consensus: MCHX

Match Group, Inc. MTCH: This social networking company has gained 64.2% in the past year. The current fiscal Zacks Consensus EPS Estimate for this Zacks Rank #2 company remains unchanged in the last 30 days.

Price and Consensus: MTCH

The Trade Desk (TTD - Free Report) : This cloud-based advertising platform has gained 153.9% in the past year. The current fiscal Zacks Consensus EPS Estimate for this Zacks Rank #1 company remains unchanged in the last 30 days.

Price and Consensus: TTD

More Stock News: This Is Bigger than the iPhone!

It could become the mother of all technological revolutions. Apple sold a mere 1 billion iPhones in 10 years but a new breakthrough is expected to generate more than 27 billion devices in just 3 years, creating a $1.7 trillion market.

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The Trade Desk Inc. (TTD) - free report >>

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Autohome Inc. (ATHM) - free report >>