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Net Stocks: Good Value Hunting


Jason Avilio, by nature and occupation, is bullish on the Internet. But in early January, Avilio wrote that Net stock prices were at worrisome heights. Even if fourth-quarter profits were good (they ended up about as good as expected), stocks might get hurt, he warned. Avilio says Net stocks are still priced as if companies will beat analyst expectations through 2006. And frankly, he is skeptical that they will.

Net stocks are nowhere as frothy as they were during the dot-com boom, but they're still pricey. That means any disappointment, especially from high-profile companies such as Google (GOOG) and Yahoo! (YHOO), weighs heavily on the entire sector. At yearend, the BW Web 20, our portfolio of blue-chip Net companies, was up 30% since our last semi-annual revision in August. With the recent pullback Avilio foresaw, it's up just 11.5%. That's not bad: It beats the Standard & Poor's (MHP) 500-stock index' 5% gain but just trails the 12% for the AMEX Interactive Week index (IIX) Web composite.

As we visit the portfolio again, we're keeping an extra-sharp eye out for value. To make room for better-priced stocks, we are dropping six. Audible (ADBL), which sells downloads of audio books, and Amazon.com (AMZN) are out because of their high price-earnings ratios (over 50 for Audible; 64 for Amazon). The Web real estate company ZipRealty (ZIPR), Chinese interactive-game company Shanda Interactive, and online wireless-phone merchant InPhonic (INPC) leave on weak earnings. Provide Commerce (L), an online florist, falls out because it was just acquired.

Our hunt for lower p-e ratios produced four of six new picks, two from well-known niches: online brokerage and advertising. Stockbroker TD Ameritrade's (AMTD) merger with TD Waterhouse could generate enough growth to justify its 22 p-e: Merrill Lynch (MER) analyst Harold Pinschmidt expects savings to begin by fiscal 2007, as management tries to reprise its successful merger with Datek Online Holdings (AMTD). Digitas is the No. 2 online pure-play ad agency behind Web 20 member aQuantive (AQNT), but Digitas trades at 21 times 2006 estimated earnings, about a third of aQuantive's p-e.

Two other entries are from more obscure parts of the New Economy. WebSideStory (WSSI) makes software for e-merchants to track what consumers do on their sites and what prompts them to buy. Jon Nordmark, chief executive officer of eBags, says this allows e-merchants to spend less on advertising. The stock trades at 25 times earnings. Cheaper yet is J2 Global Communications (JCOM), whose eFax service converts faxes to e-mail for storage and recordkeeping. CEO Scott Turrichi says J2 expects to make about $2.40 a share this year, and the stock goes for just 17 times earnings.

Even with our concern about valuations, we're willing to reach out to some pricier companies -- Blackboard (BBBB) and VistaPrint (VPRT) -- because of their excellent prospects. Blackboard's software lets colleges do everything from podcasting lectures to tracking prefunded student debit accounts so Junior can pay for coffee at an off-campus Starbucks (SBUX) with his school ID. With projected profit growth close to 25% a year, its p-e of 37 isn't out of line. VistaPrint has patented ways to batch thousands of small jobs and print them cheaply. Goldman Sachs (GS) analyst Anthony Noto says margins are expanding as VistaPrint grows. The rub is its stiff 76 p-e.

Web stocks could have a few tough months as the market reappraises how much to pay for growth. Even with our changes, the average p-e of Web 20 stocks is 38. That's still more than twice the p-e of the S&P 500. But with the Web economy growing about six times faster than the overall economy, it's a reasonable balance of risk and reward.

By Timothy J. Mullaney


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