3 Choices from the Restorative Internet Software and Services Industry


The outlook for the Internet-Software and Services industry looks mixed. The poor performance at the beginning of the year is mainly due to the lingering effects of the pandemic, which has hurt a number of players. Estimates have been increasing since May as the pandemic subsides. However, some companies have been positively affected by the pandemic and the digitization trend it has created. The diversity of players in this group causes some dissonance.

Being the backbone of the digital economy, it’s hard to see this industry doing poorly over the long term. Overall, some of these long-term trends are showing up this year, even as concerns about a slowing economy loom large in 2023. Negative economic indicators, inflation and geopolitical tensions affect most players, but some are better equipped than others to cope.

Despite the blows the industry has taken this year, valuations still look rich. However, this may be the time to find beaten-down stocks with better stopping power or strong long-term potential. Our picks are NetEase (NTES), RingCentral (RNG), and Verisign (VRSN).

About the Industry

The Internet Software and Services industry is a relatively small industry primarily engaged in providing platforms, networks, solutions and services for online businesses and facilitating customer interaction and use of Internet-based services.

Top topics that rule the industry

  • The overall impact of COVID is mixed for the industry. While requiring employees to work from home, the technology-centric industry by nature had relatively little problem with this. On the other hand, business continuity concerns have accelerated the shift to cloud-based work for many companies, while both business-related and other service providers have moved to Internet-based channels. Another big segment doing a large amount of online business was retail. All these moves were positive for the industry (revenue-wise) and partially offset the negative impact of declining business in brick-and-mortar players. At least some of the positives will outlive the pandemic. In other cases, a return to physical operations is still in progress and is hampered by new strains of the virus, inflation and other concerns.

  • Geopolitical tensions in Europe are affecting oil prices and certain supply chains, and therefore large segments of the economy. Most experts fear that the Fed’s actions to curb inflation are pushing us into a recession. The current environment favors a negative outlook for 2023, as any improvement in the overall level of economic growth improves the industry’s prospects.

  • The increase in the volume of business managed through the cloud and the increasing demand for software and service enablement implies the establishment of infrastructure that increases the costs of the players. This causes large fluctuations in profitability as new infrastructure wears out and new debt is serviced. So profitability remains a challenge even for players that have seen revenue growth accelerate as a result of the pandemic. Current inflationary conditions are also a cause for concern.

  • The level of technology adoption by businesses and the proliferation of connected consumer devices that can help people connect and do business online are also influencing growth. The high penetration of mobile devices among users and the pandemic-driven necessity are pushing more enterprises to adopt the technology, which they had previously shied away from due to cost. This is positive for the industry.

The Zacks Industry Rank indicates an improved outlook

The Zacks Internet – Software & Services industry is located within the broader Zacks Computer & Technology sector. It carries a Zacks Industry Rank of #93, placing it in the top 37% of over 250 Zacks ranked industries. Our research shows that the top 50% of Zacks Rank industries outperform the bottom 50% by 2-to-1.

The group’s Zacks Industry Rank, which is an average of the Zacks Rank of all member stocks, indicates that the industry is currently in recovery mode.

The industry’s ranking in the top 50% of Zacks rankings is because the earnings outlook for its constituent companies is improving overall. The revisions to overall estimates reflect increased analyst optimism since May, and the group’s overall profit fell by just 1.6% over the past year. The estimate for 2023 is still lower at 35%.

Before introducing a few stocks you may want to consider for your portfolio, let’s take a look at the industry’s recent stock performance and valuation picture.

Stock Market Performance of the Industry Remains Weak

The Zacks Internet – Software & Services Industry’s performance over the past year shows that it has underperformed the broader Zacks Computer & Technology Sector as well as the S&P 500 over the period. But while the discount to the S&P 500 is significant, it has traded closer to a sector that hasn’t had much success in the face of current macro concerns, especially in the past few months.

The industry’s aggregate share price has fallen 50.3% over the past year, compared with the broader sector’s 33.6% decline and the S&P 500’s 16.9% decline.

One Year Price Performance

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Current Assessment of the Industry

While many players are still making losses, the industry as a whole continues to turn a profit. Therefore, based on the forward 12-month price-to-earnings (P/E) ratio, we see the industry trading at a multiple of 30.7X, well below the industry average of 52.6X over the past year. However, the S&P 500’s P/E is just 17.7X (the average over the past year is 17.9X). The industry is also overvalued compared to the sector’s 12-month forward P/E of 21.1X (average over the past year).

The industry traded up from 75.1X to 29.0X year-over-year, as shown in the chart below.

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

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3 stocks worth considering

NetEase, Inc. (NTES): Hangzhou-based NetEase provides online services in China that focus on a variety of content, including games, music, other services and education (including dictionary, translation and a range of smart devices). Its products and services focus on community, communication and commerce.

NetEase is currently building its international business through new game content that attracts international audiences. For this purpose, it has created its own studios in Japan, Europe and North America and forms creative talents in these regions. It also extends access to consoles beyond PCs and mobile devices and facilitates seamless cross-device play, helping to further grow the user base. As evidenced by the high revenue growth rate, its educational tools are very popular. The music business continues to grow with daily and monthly users holding steady even as ad-supported levels return. In addition, the content library continues to grow.

Shares of this Zacks Rank #2 (Buy) company have fallen 41.5% over the past year. The Zacks Consensus Estimate for 2022 loss EPS has risen 37 cents (8.5%) over the past 60 days. Earnings estimates for 2023 rose 35 cents (7.6%).

Grade and Consensus: NTES

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RingCentral, Inc. (RNG): Belmont, CA-based RingCentral provides software-as-a-service solutions that enable North American businesses to communicate, collaborate and connect. The company offers business cloud communications and contact center solutions. It serves enterprises, SMEs, professionals and others across a wide range of industries, including financial services, education, healthcare, legal services, real estate, retail, technology, insurance, construction, hospitality, government and local government.

RingCentral is growing on the back of several megatrends, including the pandemic-induced shift to hybrid work, the increasing adoption of mobility solutions by enterprises, and an increasingly distributed workforce, all of which are driving the need for a unified communications and contact center. solutions. When these are cloud-enabled, everything is better integrated, safer, more efficient and cost-effective. With more than 75,000 developers, more than 150 pre-built phone apps, and an ecosystem of more than 330 pre-built applications as unified communications and contact center solutions, it’s no surprise that RingCentral is in the leadership quadrant of Gartner’s latest report. The company already has $2 billion in recurring revenue and is on track to easily surpass that next year.

All of this, of course, doesn’t mean that the company isn’t seeing the economic slowdown and wage inflation that the rest of the market is experiencing. The management is rationalizing the workforce to match the changing market scenario. But that doesn’t take into account that it’s a rapidly expanding market worldwide with a very low (single-digit) penetration rate, according to Synergy Research. In addition, Synergy believes that RingCentral is the leader in paid seats in UCaaS with over 20% market share, more than double that of the second and third place vendors. So there is a huge scope for growth.

Shares of this Zacks Rank #2 company have declined 83.5% over the past year. Its estimate for 2022 is up 4 cents (2.1%) over the past 60 days. The 2023 estimate is up 28 cents (11.2%) over the same period.

Price and Consensus: RNG

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VeriSign, Inc. (VRSN): Reston, Va-based VeriSign provides Internet infrastructure services, primarily domain name registration services, as well as infrastructure provisioning services.

Verisign benefits from price increases of up to 7% under the Third Amendment to the .com Registry Agreement with ICANN and up to 10% on .net registrations. The stable nature of business associated with digital transformation leads to relatively stable cash flow. However, like any company, it is affected by rising costs, a broader economic slowdown and weak business in China. Competition from Google’s free public domain name service is also a concern.

Shares of this Zacks Rank #2 company have fallen 19.1% over the past year. The Zacks Consensus Estimate for 2022 EPS rose a penny, while the Zacks Consensus Estimate for 2023 EPS was unchanged over the past 60 days.

Price and Consensus: VRSN

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