Picking the Right Internet Stocks

Picking the Right Internet Stocks

 

Picking the Right Internet Stocks

 


by Hal Plotkin
Silicon Valley Correspondent

Figuring out which Internet companies have the best chance to succeed over the long run takes logic, industry knowledge, and a willingness to ask unfamiliar questions.

“The industry is beginning to develop a new set of metrics,” that help investors determine the relative merits of different online companies, says Laird Foshay, founder of Menlo Park, Calif.-based Investools, an online company that sells stock-picking advice. Investools was recently acquired by Houston-based Telescan Inc. {TSCN} for $48.6 million in stock. General Electric Co. {GE}, the parent company of CNBC.com, has a significant minority interest in Telescan.

Foshay says that when it comes to picking Internet stocks, the most seasoned investors base their decisions on business fundamentals rather than on hype or potentially misleading statistics, such as raw page-view counts. Those fundamentals include the cost of acquiring new customers, the lifetime value of a customer, and an important but relatively new measure of online performance: revenue per-page view.

“There are a lot of sites that tout high page views,” Foshay says. “But if you look a little deeper, you find out they aren’t taking in much in the way of revenue. I worry about companies like that.”

Few online companies routinely make revenue-per-page-view statistics available. Nonetheless, investors can compare the performance of different Internet companies by doing the math themselves, for example, by dividing a company’s quarterly revenue by the number of page views it claims for that quarter.

“Comparing the numbers helps you understand if a company is capitalizing on their opportunity,” Foshay says.

What to Look for in an Internet Stock
  • Base your decisions on business fundamentals, not hype
  • Be wary of raw-page-view statistics
  • Is the company’s industry fragmented?
  • Consumer-oriented Internet companies need:
    • expertise in a subject area,
    • a large community of users,
    • or the ability to compete aggressively on price
  • Is the site clear, intuitive, and easy-to-use?
  • Does the site have ample product information?
  • How well does the company work with third-party intermediaries?
  • Does the company sell digital or non-digital goods?

Some large Internet sites take in as little as $200,000 a month, despite generating 20 million or more monthly page views.

By contrast, some smaller, more narrowly targeted sites can generate twice that revenue on one-tenth the number of monthly page views.

“At some point, those economics will take over, common across all industries,” Foshay says. “Profits really do matter.”

There are some other simple things investors can do to separate hype from reality when picking Internet stocks.

For online companies selling business to business, for example, one critical factor that will determine success or failure is whether a company’s strategy reflects an understanding of the balance of power in the industry’s supply chain, says Leah Knight, senior analyst at Dataquest, based in San Jose, Calif. “It’s not enough for someone to come in and say they’re going to revolutionize an industry by bringing it online,” she says.

Instead, Knight says investors should consider how fragmented the industry is. If it is a fragmented industry, “the site with the largest number of products from the largest number of suppliers” will usually have an edge.

Similarly, online companies that sell directly to consumers must have at least one of three things going for them, says Blaine Mathieu, a Dataquest analyst. In order to prosper, consumer-oriented Internet companies need either expertise in a subject area, a large community of users, or the ability to compete aggressively on price. “If a company doesn’t have one of those, they’re going to be in trouble,” he says.

It’s often possible to determine whether an online company has or can develop those assets simply by visiting the company’s Web site. When evaluating an e-commerce company’s ability to build a loyal following, for example, Mathieu says one of the first things to look for is the online cash register.

“You want to see if they have done what they can to facilitate buying,” Mathieu says. “Is it clear, intuitive, and easy-to-use? Does the site have ample product information? Are there clear guarantees for security, shipping, and good return policies?”

Investors evaluating consumer-oriented Web firms should also pay close attention to how well those companies work with the online third-party shopping intermediaries who are expected to play an increasingly important role in e-commerce. There are already several such sites, most notably San Francisco-based Brodia.com, and epinions.com, based in Mountain View, Calif., which is slated to begin operations within the next few weeks.

Sites operated by third-party intermediaries help shoppers quickly and easily find what they’re looking for at the best prices. If you search for a particular item on those sites and the company you’re considering investing in, which sells that product, doesn’t show up, that could be telling you something very important, Mathieu says.

“This Christmas, you’re going to see [third-party online intermediaries] become a lot more sophisticated,” he adds. “They’re going to drive a lot of sales.”

Another factor to consider when evaluating an Internet company’s long-term prospects is whether it sells digital or non-digital goods. Non-digital content, items that must be shipped to purchasers, such as books or consumer goods, usually have the lowest profit margins, Foshay says. On the other hand, digital content, which can be manufactured and distributed far less expensively, offers the best chance of high returns.

“That’s been the secret to Microsoft’s success: huge gross margins,” Foshay says. “In the future, the online companies that will be most successful are the ones that can use the Internet to not only sell, but also distribute, their products.”

About the Author /

hplotkin@plotkin.com

<p>My published work since 1985 has focused mostly on public policy, technology, science, education and business. I’ve written more than 600 articles for a variety of magazines, journals and newspapers on these often interrelated subjects. The topics I have covered include analysis of progressive approaches to higher education, entrepreneurial trends, e-learning strategies, business management, open source software, alternative energy research and development, voting technologies, streaming media platforms, online electioneering, biotech research, patent and tax law reform, federal nanotechnology policies and tech stocks.</p>