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Internet Services Industry Outlook: Growth at the Cost of Rising Expenses

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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. Alphabet (GOOGL - Free Report) , Facebook (FB - Free Report) , Baidu (BIDU - Free Report) and Akamai AKAM are some of the larger players in the space while Dropbox (DBX - Free Report) , Etsy (ETSY - Free Report) , Shopify (SHOP - Free Report) , ANGI Homeservices ANGI, Uber (UBER - Free Report) , Lyft (LYFT - Free Report) and Trivago (TRVG - Free Report) are some of the emerging players.

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 #171, which places it among the bottom 33% 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 a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts aren’t too optimistic about this group’s earnings growth potential. While the industry’s earnings estimate for the current year is up 3.0% since November last year, there was a sizeable upward adjustment in Jan 2019 that was almost totally adjusted back down in Jun 2019.

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 because of increasing cost of operation/expansion, rising debt levels and declining cash flow.

The industry has declined 1.6% over this period compared to the S&P 500 index’s 8.8% gain and broader sector’s 11.8% 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 25.43X compared to the S&P 500’s 17.70X. It is also above the sector’s forward-12-month P/E of 21.08X.

While within its annual range of 32.21X to 22.46X, the industry is currently trading above the median value of 24.78X, as the chart below shows.

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

Bottom Line

Other than the operational costs and rising debt levels, there is currently a regulatory overhang, as Alphabet and Facebook, both leading players, are under government investigation, raising questions about their operating models. These factors together have depressed prices, despite the fact that the constituent companies otherwise have solid growth prospects.

There are a number of buy-ranked stocks in sector, a few of which are highlighted below. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

 

Akamai Technologies (AKAM): This delivery network (CDN) and cloud infrastructure service provider has gained 22.1% in the past year. The Zacks #2 (Buy)-ranked company’s current fiscal Zacks Consensus EPS Estimate for the company is up 2.3% in the last 30 days.

Price and Consensus: AKAM

 

Healthstream Inc (HSTM - Free Report) : This supplier of solutions including workforce development, training & learning management, talent management, credentialing, privileging, provider enrollment, performance assessment, and simulation-based management education to healthcare providers is up 4.6% in the past year. The current fiscal Zacks Consensus EPS Estimate for this Zacks Rank #1 company is up 7.9% in the last 30 days.

Price and Consensus: HSTM

Eventbrite Inc. (EB - Free Report) : This online event planning, marketing, promoting and ticket-selling company has dropped 43.9% 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: EB

 

Match Group, Inc. (MTCH - Free Report) : This social networking company has gained 56.9% 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

 

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