By Timothy J. Mullaney BusinessWeek's Web 20, a model portfolio of profitable Internet companies, has surged 21% since Aug. 10, 2004. That whips the gain of about 9% of both Standard & Poor's 500-stock index and the Nasdaq composite index, as well as the 6.5% return of the Amex Interactive Week Internet Index.
(BusinessWeek first came up with the Web 20 in 2002 -- originally called the Real World Internet Index -- as a way to explore investing in the Internet. We have updated it about every six months since then, dropping lackluster performers and adding companies that we think have promise.)
LEADING THE PACK. Stocks that were added to the Web 20 in August, 2004, have led the way since then. Google (GOOG), which we included at the IPO price of $85, has shot up 117.6%, to $185. Provide Commerce (PRVD), which runs Proflowers.com, has risen 55.6%, to $27.73. Indian tech consulting giant Infosys (INFY) has surged 24.4%, to $60.46. Online ad agency aQuantive (AQNT) is up 19.62, to $10.61.
E-jeweler Blue Nile (NILE) has climbed 12.2%, to $26.29. And mortgage lender IndyMac Bancorp (NDE), which uses the Internet to link a network of mortgage brokers who place most of its loans, has increased only 3.83%, to $34.99. But that's O.K.: IndyMac was intended to be a kind of slow-and-steady stock that would offset any mistakes we made adding a riskier stock.
The failures since August: DVD-by-mail service Netflix (NFLX), security-software maker Symantec (SYMC), Amazon.com (AMZN), IAC/InterActiveCorp (IACI), and -- remarkably -- online auctioneer eBay (EBAY). Netflix is off 31.8%, hammered by the entry of store-based rival Blockbuster (BBI) into the online part of the business.
NEW FACES. Amazon and IAC have also seen their growth rates slow down. eBay missed quarterly estimates for the first time ever in the fourth quarter of 2004, causing its shares to fall 15.6% since August. And Symantec got hammered when it announced plans to buy storage-software vendor Veritas Software (VRTS) as part of a plan to offer a broader range of products to corporations: Its shares are down 18.4% since August.
The smart strategy for investors of Internet stocks now is to exploit new trends and deemphasize areas where growth has slowed, such as e-commerce and e-finance. Both Ameritrade (AMTD) and E*Trade (ET) have been hampered by lower trading commissions, even as they pursue other strategies to boost profits. Trends probably worth betting on are strong expected growth in online advertising, the increased consumer acceptance of comparison-shopping sites, and the international expansion of the Internet. So as a result, we're going to make some modifications to the Web 20.
Changes in the portfolio makeup went into effect at the close of trading on Apr. 15. And we have 100 shares of each stock in the portfolio, unless it split after it was added. So here goes. The new members of the Web 20 are:
Shopping.com: One of the clearest beneficiaries of the push to boost online comparison shopping, this portal lets you compare prices at 10,000 online stores that carry everything from digital cameras to barbecue grills. It makes money by selling ad space alongside and at the top of its listings, and it's a way to bet on the continued growth of e-commerce. Analysts think Shopping.com (SHOP) will earn 74? a share this year, or about $22 million. That puts its price-to-earnings ratio at 21-- quite respectable, considering profits doubled last year and are expected to grow 50% this year.
InPhonic: Like Shopping.com, InPhonic (INPC), which went public last year, is a play on online comparison shopping, plus the growth of wireless phone services. Its key business is Wirefly.com, a site that compares prices of wireless phone plans and then refers you to the carrier of your choice.
But InPhonic has an intriguing sideline: It runs a prepaid wireless phone service of its own, called Liberty Wireless, for customers who flunk major carriers' credit checks. For 2005, analysts expect InPhonic to earn close to $25 million, up from a loss of $1.1 million last year. Wall Street expects InPhonic to grow 30% annually over the next five years.
Infospace: Its transformation from Eliot Spitzer's whipping boy into a solid, profitable company is pretty much complete. The Internet outfit was among those stocks that got Merrill Lynch (MER) in hot water for overly favorable investment research. Today, Infospace (INSP) sells games and other data delivered over mobile phones, which the company says will generate up to $185 million in 2005 revenue. It also makes money from online advertising, mostly related to search results and directory listings. That business is expected to produce up to $210 million in 2005 revenue.
All told, analysts think Infospace will earn profits of about $70 million this year. The price-to-earnings ratio is 22 -- nothing like it was in the bubble days of 2000, when Merrill's Henry Blodget rated the issue a buy at a price equal to 578 times then-projected 2001 profits.
Shanda Interactive Entertainment: Shanda (SNDA) is one of the biggest, most profitable Web companies to come out of China, the world's fastest-growing Internet market. And Shanda, which develops and distributes online games, trades at 22 times this year's projected profits. It's the best-performing tech IPO of 2004 -- even better than Google -- and still pretty cheap.
ZipRealty: The outfit's idea is to use the Internet to sell real estate faster and cheaper. Customers who go online to screen houses tend to make decisions and close deals faster than others once they finally hire an agent. That lets experienced ZipRealty (ZIPR) agents close nearly twice as many deals per sales rep as the industry average. To lure customers, Zip gives rebates of 20% to 25% of real-estate commissions.
CEO Eric Danziger says Zip will make about $10 million in 2005. At about 36 times this year's projected earnings, the stock is more expensive than many Web 20 companies. But when you factor in the 25% annual profit growth projected by analysts over the next five years, it's slightly less expensive than the S&P 500.
To make room for these newcomers, I'll drop these stalwarts:
IAC/InterActive: IAC is spinning off its travel businesses, leaving Barry Diller's Web conglomerate a profitable but not terribly exciting company headlined by its HSN cable-TV shopping network and Ticketmaster. Growth within these businesses is less than torrid. We'll decide later in the year whether to include the company's travel businesses, which will be renamed Expedia, in the Web 20.
Netflix: Blockbuster hasn't stolen Netflix's customers, just crushed its short-term profits. Netflix just passed 3 million users, most of whom pay $18 a month for unlimited movie rentals. But the outfit cut its monthly price from $22 because Blockbuster is charging $15, leading the company to forecast a net loss of up to $15 million for 2005.
Ameritrade: With online trading off sharply, having both Ameritrade and E*Trade in the Web 20 is just one broker too many. E*Trade stays because its banking business partly offsets the cyclicality of trading, and also because Ameritrade on Apr. 12 trimmed the high end of its earnings guidance range by about 4%.
Symantec: Analysts worry that Microsoft (MSFT) will cut the information security provider's market share. The software giant recently bought Sybari Software, which competes with Symantec in enterprise virus protection.
IndyMac: Nothing really is wrong here, but if housing cools off this year, as many experts predict, then there will be better places to be than mortgage banks.
The new companies being added to the Web 20 are mostly smaller and less well known than the ones being replaced -- and went public well after the boom and bust. They demonstrate that there's still a pretty healthy market for innovation and industry-busting change propelled by the Internet -- and probably opportunity for investors as well. Mullaney is BusinessWeek's e-Business editor in New York