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Internet-Commerce Outlook: Weak Earnings Outlook & Rich Valuation

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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 joining these to facilitate 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 commerce is developing into a major trend as are chatbots that facilitate back-end operations and customer care.

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 necessitating deep discounting, which keeps prices down.

A peculiarity of the market is Amazon’s (AMZN - Free Report) 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 others to partner with Alphabet’s GOOGL Google to fill technology gaps. Expedia EXPE, eBay EBAY, and Chinese companies Alibaba BABA and JD are other significant players.

Here are the three major themes in the industry:

  • Both ecommerce pureplays 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. So all retailers are moving toward a hybrid/omnichannel model, where customers can get quick delivery or pick up the items ordered from a physical outlet close to them, at their convenience. Self-driven delivery vehicles and drones are already on the horizon to deal with logistics problems and make deliveries smoother and cheaper.
  • Because of the many details involved in satisfying a customer, data mining has grown in importance and the party controlling the customer’s data is the best positioned to deliver the desired experience. Most of the big ecommerce players are also into payments processing, which gives them further insight into a customer’s tastes, preferences and buying habits. As machines read and process this data, they can create programs and processes to maximize customer satisfaction and drive sales. In the near future, more and more retailers will harness big data to boost their prospects.
  • 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. However, profitability is likely to remain under pressure because of the need to build out infrastructure to support the strong revenue growth. Recent research shows that experiential retail will become more of a thing in the near future as technology companies collaborate with retailers to help these technologies go mainstream. This is likely to be an important area of investment for retailers. The bigger marketplaces will be able to offset some of the increased investment with a focus on advertising, which carries higher margins.

Zacks Industry Rank Indicates Near-Term Pressures

The Zacks Electronic - Commerce Industry is a 29-stock group within the broader Zacks Retail And Wholesale Sector. It carries a Zacks Industry Rank #213, which places it at the bottom 16% 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. So the group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates improving near-term prospects.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of deterioration in the earnings outlook of constituent companies in aggregate. Looking at the aggregate earnings estimate revisions in the past year, it appears that the industry’s earnings estimate for 2019 is down 29.6% and for 2020  is down 20.6%.

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 Shareholder Returns

The Zacks Electronic - Commerce Industry has trailed both the broader Zacks Retail and Wholesale Sector as well as the S&P 500 index over the past year.

So we see that the stocks in this industry have collectively gained 19.3% over the past year, while the Zacks S&P 500 Composite and Zacks Retail and Wholesale Sector have gained 24.7% and 33.0%, respectively.

One-Year Price Performance

Industry’s Current Valuation

On the basis of the forward 12-month price-to-earnings (P/E) ratio, which is a commonly used method of valuing electronics focused companies, we see that the industry is currently trading at 41.9X compared to the S&P 500’s 19.0X. It is also above the sector’s forward-12-month P/E of 22.8X.

Over the past year, the industry has traded as high as 43.9X, as low as 36.2X and at the median of 40.9X, as the chart below shows.

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

Bottom Line

It’s better to avoid the industry right now unless there’s a really compelling reason to buy, as the earnings outlook is negative and the valuation remains rich. The negative prospects are evident in the fact that there’s only one company in the industry with a Buy rank (Zacks Ranks #1 and #2). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

So here are some stock picks for those willing to take a chance-

ASOS PLS ADR ASOMY: The Zacks Rank #2 stock is down 1.0% over the past year. The Zacks Consensus Estimate for the current-year EPS rose 3.0% in the last 60 days.

Price and Consensus: ASOMY Inc BABA: The Zacks Rank #1 stock has gained 45.4% over the past year. The Zacks Consensus Estimate for the current-year EPS is up down a couple of cents in the last 60 days.

Price and Consensus: BABA Inc. (AMZN - Free Report) : The Zacks Rank #1 stock has gained 10.6% over the past year. The Zacks Consensus Estimate for the current-year EPS is down 1.2% in the last 60 days.

Price and Consensus: AMZN

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