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Opportunities Abound in the Internet Services Industry: 2 Picks
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Macro factors currently driving the economy, such as the relatively high interest rates, continued strength in labor markets, supply chain issues (though minimal right now and in pockets) and so forth have a varied impact on players in the extremely diverse Internet – Services industry. However, the outlook for the industry is positively correlated with a stronger economy.
Additionally, 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. Therefore, the possibility of rate cuts this year makes us incrementally positive about the Internet Services industry. Valuations have risen over the past year, but opportunities abound.
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 generally operate two models: an ad-based model and an ad-free model where the service is charged. Alphabet, Baidu and Akamai are some of the larger players while Crexendo, Upwork, Dropbox, Etsy, Shopify, Uber, Lyft and Trivago are some of the emerging players. Large players (mainly Alphabet) tend to skew averages.
Because of the diversity of services offered, it is difficult to identify industrywide factors that could affect all players. The effect of macro factors such as inflation, rate hikes, supply chain issues and so forth vary.
Factors Determining Industry Performance
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. Given the secular growth prospects, companies continued infrastructure investments through 2023 and this year, despite high interest rates. With interest rates expected to come down this year, capex is likely to continue.
Alphabet has an outsized impact on industry averages. Therefore, cost rationalization at the company, including a reduction in its workforce and office space, is having a positive effect on industry margins. While Alphabet’s long-term debt has been relatively steady this year, the industry’s debt is increasing. Two things typically trigger major increases in debt levels (and the two are not mutually exclusive), i.e. fixed asset investment and acquisitions. It appears that there is ongoing consolidation in the industry ex-Alphabet, as seen from the aggregated intangibles balance. Additionally, ex-Alphabet PP&E is also soaring, meaning that companies are investing heavily in their infrastructure.
Traffic/customer 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, to use the service more or spend more time on the platform, much like a store owner would try to 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 increasingly 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 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. They are increasing operational efficiency and the scope for growth. Since larger companies and companies dealing directly with customers have direct access to customer data, there is a corresponding effect on the competitive dynamics as well.
Zacks Industry Rank Approaching Neutral
The Zacks Internet - Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #143, which places it among the bottom 43% of 250 odd 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 a bottom in December 2023 gradually climbing back thereafter to a high in April that it has more or less maintained since. Overall, the industry’s earnings estimate for 2024 is up 11.8% from August 2023. The average earnings estimate for 2025 is up 5.3%.
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 bottom 50% of the Zacks-ranked industries should be viewed with caution, even though it is fairly close to the middle.
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 Neutral on Stock Market Performance
Through most of the past year, the industry has traded at a premium to the S&P 500 although it has traded below or at par with the broader sector.
As a result, the industry’s net gain of 29.5% in the past year is short of the broader sector’s 38.6% gain and ahead of the S&P 500’s 27.5%.
One-Year Price Performance
Image Source: Zacks Investment Research
Industry's Current Valuation: Fair
On the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at a 21.03X multiple, which is a slight discount to its median value of 21.68X over the past year. It is also a slight discount to the S&P 500’s 21.69X and a greater discount to the sector’s 27.12X.
Over the past year, the industry has traded in the range of 20.05X to 23.27X, remaining at a premium to the S&P’s 17.89X to 21.69X throughout. The sector has traded in the 22.35X to 28.01X range.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
2 Solid Bets
Since the industry is highly diverse, some players are doing exceedingly well while others not so much. Both the stocks selected here, i.e. Uber Technologies and Zillow Group are rated Zacks #2 (Buy).
Uber, Inc. (UBER - Free Report) : San Francisco, California-based Uber Technologies provides ride-hailing, food delivery and freight (leasing vehicles to third parties) services through its Mobility, Delivery and Freight segments, respectively. The company operates across the Americas, Europe, Middle East and Asia.
Both its ride-sharing and delivery platforms are growing in popularity with monthly active platform consumers (MAPC) increasing 16% and MAPC trips increasing 6%. This is generating strong demand, which along with new growth initiatives is driving the company’s results. In the last-reported quarter, gross bookings grew 19% year over year, with mobility growing 27% at constant currency (CC) and delivery 17% at CC. Trips were up 21%, the sixth straight quarter of 20%+ growth. Driven by the strength in its cash flows, management the company started repurchasing shares for the first time.
As a result, the company beat the Zacks Consensus Estimate by 51.6% in the last quarter on revenue that beat by around 1.3%. The 2024 earnings estimate has increased 19 cents (22.4%) in the last 30 days while the 2025 estimate increased 10 cents (4.6%) in the last 60 days. Analysts are looking for 16.5% revenue growth and 19.5% earnings growth this year, followed by 16.8% revenue growth and 117.6% earnings growth in the next.
The shares are up 65.7% over the past year.
Price and Consensus: UBER
Image Source: Zacks Investment Research
Zillow Group, Inc. (ZG - Free Report) : Seattle, WA-based Zillow Group is a holding company of its two main operating subsidiaries Zillow and Trulia. It is involved in facilitating real estate transactions including the renting, buying and selling of homes, as well as home improvement and financing transactions on its software and technology platform. Its Zillow, Trulia, StreetEasy, HotPads, Naked Apartments, RealEstate.com and OutEast.com brands cater to the needs of millions of customers in the US.
Zillow’s recent results are indicative of an improving home buying environment, as interest rates are more likely to head south than in the other direction. At the same time, the still-high mortgage rates mean that the rental market remains robust (especially the multi-family segment).
In the last quarter, the company beat earnings estimates by 25.8%, with analysts taking their 2024 estimates up by a penny and 2025 estimates by 3 cents. At the current level, the estimates reflect expectations of 12.8% revenue growth and 14.3% earnings growth this year followed by 13.4% revenue growth and 43.2% earnings growth in the next.
The shares have appreciated 9.2% in the past year.
Price and Consensus: ZG
Image Source: Zacks Investment Research
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Opportunities Abound in the Internet Services Industry: 2 Picks
Macro factors currently driving the economy, such as the relatively high interest rates, continued strength in labor markets, supply chain issues (though minimal right now and in pockets) and so forth have a varied impact on players in the extremely diverse Internet – Services industry. However, the outlook for the industry is positively correlated with a stronger economy.
Additionally, 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. Therefore, the possibility of rate cuts this year makes us incrementally positive about the Internet Services industry. Valuations have risen over the past year, but opportunities abound.
Our picks are Uber (UBER - Free Report) and Zillow Group (ZG - 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 generally operate two models: an ad-based model and an ad-free model where the service is charged. Alphabet, Baidu and Akamai are some of the larger players while Crexendo, Upwork, Dropbox, Etsy, Shopify, Uber, Lyft and Trivago are some of the emerging players. Large players (mainly Alphabet) tend to skew averages.
Because of the diversity of services offered, it is difficult to identify industrywide factors that could affect all players. The effect of macro factors such as inflation, rate hikes, supply chain issues and so forth vary.
Factors Determining Industry Performance
Zacks Industry Rank Approaching Neutral
The Zacks Internet - Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #143, which places it among the bottom 43% of 250 odd 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 a bottom in December 2023 gradually climbing back thereafter to a high in April that it has more or less maintained since. Overall, the industry’s earnings estimate for 2024 is up 11.8% from August 2023. The average earnings estimate for 2025 is up 5.3%.
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 bottom 50% of the Zacks-ranked industries should be viewed with caution, even though it is fairly close to the middle.
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 Neutral on Stock Market Performance
Through most of the past year, the industry has traded at a premium to the S&P 500 although it has traded below or at par with the broader sector.
As a result, the industry’s net gain of 29.5% in the past year is short of the broader sector’s 38.6% gain and ahead of the S&P 500’s 27.5%.
One-Year Price Performance
Image Source: Zacks Investment Research
Industry's Current Valuation: Fair
On the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at a 21.03X multiple, which is a slight discount to its median value of 21.68X over the past year. It is also a slight discount to the S&P 500’s 21.69X and a greater discount to the sector’s 27.12X.
Over the past year, the industry has traded in the range of 20.05X to 23.27X, remaining at a premium to the S&P’s 17.89X to 21.69X throughout. The sector has traded in the 22.35X to 28.01X range.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
2 Solid Bets
Since the industry is highly diverse, some players are doing exceedingly well while others not so much. Both the stocks selected here, i.e. Uber Technologies and Zillow Group are rated Zacks #2 (Buy).
Uber, Inc. (UBER - Free Report) : San Francisco, California-based Uber Technologies provides ride-hailing, food delivery and freight (leasing vehicles to third parties) services through its Mobility, Delivery and Freight segments, respectively. The company operates across the Americas, Europe, Middle East and Asia.
Both its ride-sharing and delivery platforms are growing in popularity with monthly active platform consumers (MAPC) increasing 16% and MAPC trips increasing 6%. This is generating strong demand, which along with new growth initiatives is driving the company’s results. In the last-reported quarter, gross bookings grew 19% year over year, with mobility growing 27% at constant currency (CC) and delivery 17% at CC. Trips were up 21%, the sixth straight quarter of 20%+ growth. Driven by the strength in its cash flows, management the company started repurchasing shares for the first time.
As a result, the company beat the Zacks Consensus Estimate by 51.6% in the last quarter on revenue that beat by around 1.3%. The 2024 earnings estimate has increased 19 cents (22.4%) in the last 30 days while the 2025 estimate increased 10 cents (4.6%) in the last 60 days. Analysts are looking for 16.5% revenue growth and 19.5% earnings growth this year, followed by 16.8% revenue growth and 117.6% earnings growth in the next.
The shares are up 65.7% over the past year.
Price and Consensus: UBER
Image Source: Zacks Investment Research
Zillow Group, Inc. (ZG - Free Report) : Seattle, WA-based Zillow Group is a holding company of its two main operating subsidiaries Zillow and Trulia. It is involved in facilitating real estate transactions including the renting, buying and selling of homes, as well as home improvement and financing transactions on its software and technology platform. Its Zillow, Trulia, StreetEasy, HotPads, Naked Apartments, RealEstate.com and OutEast.com brands cater to the needs of millions of customers in the US.
Zillow’s recent results are indicative of an improving home buying environment, as interest rates are more likely to head south than in the other direction. At the same time, the still-high mortgage rates mean that the rental market remains robust (especially the multi-family segment).
In the last quarter, the company beat earnings estimates by 25.8%, with analysts taking their 2024 estimates up by a penny and 2025 estimates by 3 cents. At the current level, the estimates reflect expectations of 12.8% revenue growth and 14.3% earnings growth this year followed by 13.4% revenue growth and 43.2% earnings growth in the next.
The shares have appreciated 9.2% in the past year.
Price and Consensus: ZG
Image Source: Zacks Investment Research