2 Troubled and Overvalued Internet Software & Services Industry Stocks – August 5, 2022

The outlook for the software and Internet services industry appears negative due to the trend of revisions in estimates over the past year, mainly due to the pandemic. However, some companies have been positively impacted by the pandemic and the rush to digitization it has generated. The diversity of actors in this group is the reason for this dissonance.

Being the backbone of the digital economy, it’s hard to see this industry performing poorly in the long term. However, the short-term outlook has deteriorated given negative economic indicators, rising inflation and geopolitical tensions. To make matters worse, the valuation remains elevated. Under these circumstances, none of the players look exciting, but we’ve chosen Squarespace (SQSP free report) and Verisign (VRSN Free Report) for further review.

About the industry

The Internet software and services industry is a relatively small industry that primarily involves enabling platforms, networks, solutions, and services for online businesses and facilitating customer interaction and use of Internet services.

Key Themes Driving the Industry

  • The overall impact of COVID has been mixed for the industry. Although this necessitated working from home for employees, the industry, being technology-centric in nature, had relatively less of an issue with this. On the other hand, business continuity issues have accelerated the shift to cloud-based work for many companies, while service providers, whether work-related or not, have also shifted to cloud-based channels. on the Internet. Another large segment that did huge amounts of online commerce was retail. All of these moves were positive for the industry (in terms of revenue) and partially offset the negative impact of the decline in physical player activity. At least some of the positive aspects will survive the pandemic. In other cases, the return to physical operations is still underway and hampered by new virus strains, inflation and other concerns.
  • Geopolitical tensions in Europe have an impact on oil prices and certain supply chains, and therefore also on large segments of the economy. And most experts fear that the Fed’s actions to contain inflation will push us into a recession. Since any improvement in the general level of economic growth improves the outlook for the industry, the current environment contributes to the negative outlook.
  • The higher volume of business operated through the cloud and the growing demand for enabling software and services require the building of infrastructure, which increases costs for players. This leads to large swings in profitability as new infrastructure is written off and new debt is repaid. So even for players who have seen revenue growth accelerate in the wake of the pandemic, profitability has remained a challenge. Current inflationary conditions are also of concern.
  • The level of technology adoption by businesses and the proliferation of connected consumer devices that could help people connect and conduct business online are also impacting growth. The high penetration of mobile devices among users and the pandemic-related necessity are pushing more and more businesses to adopt technology that they previously shunned due to the costs involved. This is positive for the industry.

Zacks’ Industry Ranking Indicates Continued Challenges

The Zacks Internet – Software & Services industry is housed in the wider Zacks IT and technology sector. It carries a Zacks Industry Ranking #152, which places it in the bottom 40% of over 250 Zacks-ranked industries. Our research shows that the top 50% of industries ranked by Zacks outperform the bottom 50% by a factor of more than 2 to 1.

That of the group Zacks Industry Rankingwhich is essentially the average of the Zacks ranking of all member stocks, indicates that while the industry is recovering from the problems caused by the pandemic, some problems remain.

The industry’s positioning in the bottom 50% of industries ranked by Zacks is due to the earnings outlook for the constituent companies as a whole continuing to deteriorate. Looking at the revisions to the overall estimates, it appears that analyst confidence in the group’s earnings growth potential for 2022 has been falling more or less steadily since last July, although it has strengthened over the past two months. . Over the past year, the average earnings estimate for 2022 has decreased by 42.2%. The 2023 estimate is down 39%.

Before outlining a few stocks you might consider for your portfolio, let’s take a look at recent stock market performance and the industry valuation picture.

Industry stock market performance suffers

Zacks Internet – Software & Services industry performance last year shows that it lagged the broader Zacks IT & Technology sector, as well as the S&P 500 for most of the year. But while the discount to the S&P 500 is substantial, and particularly in recent months, it has come closer to the sector, which has not seen a big run amid current macro concerns.

The industry’s overall stock price has fallen 29.2% over the past year, compared to the broader sector’s 21.0% decline and the S&P’s 6.9% decline. 500.

Year-over-year price performance

Image source: Zacks Investment Research

Current industry valuation is rich

While many players are still registering losses, the industry as a whole continues to generate profits. Based on the 12-month forward price-to-earnings (P/E) ratio, we see that the sector is currently trading at 44.7X, well below its median level of 61.8X over the past year. The P/E for the S&P 500, however, is only 18.0X (the median value over the past year is 20.2X). The industry is also overvalued compared to the sector’s 12-month forward P/E of 22.4X (below its median level last year).

The industry traded in the yearly range of 78.0X to 41.7X, as seen in the chart below.

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

Zacks Investment Research
Image source: Zacks Investment Research

2 stocks worth taking a closer look at

Squarespace, Inc. (SQSP Free report) : Squarespace operates a platform that allows businesses and creators to open an online store from which they can manage their online presence and brands, including across websites and domains, commerce operations electronics, marketing and planning. It also provides tools to manage social media presence.

Although the current environment is not ideal for a stock that facilitates online commerce and digitization, it is certainly where the world is heading and where consumers and businesses (especially small and medium organizations that are likely to need his services) will end in the next few years. There are also a growing number of people who need to seamlessly coordinate their online and offline operations. Therefore, Squarespace’s long-term growth prospects are promising. Near-term challenges remain, however, which will likely continue to put pressure on the stock.

Shares of this company Zacks Rank #3 (Hold) have fallen 55.1% over the past year. The Zacks consensus estimate for the 2022 loss per share has fallen 16 cents (64.0%) over the past 60 days. The revenue estimate for 2023 also fell by 16 cents (66.7%).

Pricing and Consensus: SQSP

Zacks Investment Research
Image source: Zacks Investment Research

VeriSign, Inc. (VRSN Free report) : VeriSign provides Internet infrastructure services, including domain name registration services and infrastructure assurance services.

Verisign is benefiting from a growing trend in new domain name registrations as well as price increases of up to 7% in accordance with the Third Amendment to the .com Registry Agreement with ICANN and up to 10% in .net records. The stable nature of the business related to digital transformation leads to relatively stable cash flows. However, like every other business, rising costs and the general economic downturn are also weighing on her. Competition from Google’s free public domain name service is also a concern.

Shares of this No. 3-ranked Zacks company have fallen 8.3% over the past year. The Zacks consensus estimate for the 2022 and 2023 EPS is unchanged over the past 60 days.

Pricing and Consensus: VRSN

Zacks Investment Research
Image source: Zacks Investment Research

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