Web Stocks Are Cheap Now

by: Tim Mullaney

I want to get this off my chest before the market opens, and the impact of Yahoo's soft earnings report and other badness shows up as some big cratering... The Web is cheap now.

I'm not a pollyanna: In February, when I last updated the BW Web 20 (for newbies, that's our model portfolio of profitable, emerging Net blue chips), I said Web stocks were expensive and it would be a tough six months while the intrinsic health of the Web economy got back into sync with valuations. And it has been. Only five of the 20 are up since, and seven are down 24% or more.

But this is getting ridiculous, even though a few big (and lucky) winners like J2 Global Communications (NASDAQ:JCOM) and CTrip (NASDAQ:CTRP) of the 20 are still beating the market overall. Here's a quick exercise in showing just how ridiculous.

The 20 is put together relying, uber alles, on one analytical tool. My favorite is the PEG ratio, which divides the price-to-earnings ratio nearly anyone reading this blog would know by the expected annual growth in profits over the next several years (usually five). The PEG ratio of the S&P 500 stock index is 1.32, according to Yahoo Finance.

As of July 18's close, here's what Bloomberg says about the PEG ratios of Web stocks. Of the Web 20, 11 had PEG ratios below 1.15. These include companies like Digital River (NASDAQ:DRIV), eBay (NASDAQ:EBAY), Websense (NASDAQ:WBSN), Quality Systems (NASDAQ:QSII), Netflix (NASDAQ:NFLX), Digitas (OTC:DTAS) and IAC/InterActiveCorp (IACI). They're all significantly cheaper than the general run of what's out there.

In the next group, Google (NASDAQ:GOOG) and VistaPrint (VPRT) are cheaper than the market at a 1.3 PEG. Blackboard's (NASDAQ:BBBB) at 1.5, Checkfree (CKFR) at 1.4, Ameritrade (NASDAQ:AMTD) at 1.44, and Ctrip's at 1.5. Even aQuantive (AQNT) , which had gotten pricey after tripling from 2004 to early 2006, is at 1.6. It was even cheaper, but a bunch of analysts upgraded it in the last few days precisely because it's cheap.

The only really expensive ones are Blue Nile (NASDAQ:NILE) at 2.0 and Yahoo (NASDAQ:YHOO) at 2.2 according to July 18's close, and even Yahoo's expensive in part because it has a big stake in Yahoo Japan.

Most of these numbers will be lower today, when Yahoo's bad news hits prices in more than just the aftermarket trades. Google could go under 30 times this year's earnings. You don't have to be some genius from Columbia Journalism Review to grasp that 30 times earnings for Google is a gimme.

But here's the thing.... The Internet economy is growing five to six times faster than the rest of the economy. Google, more like ten times. Know what has changed about that in the last six months as prices tanked? Nothing, that's what.

That Internet stocks are as cheap as the rest of the market -- or cheaper -- is just noise. Or just nuts.


Google's price-to-earnings ratio is 42, not the 32 times this year's projected profits I thought I had looked up. So there wasn't really any risk the stock would go below a 30 P/E if it sold off on Yahoo's earnings report. My bad.

Still, getting Google at 42 is not exactly the word's highest-flying risk. Nothing is certain in life, but companies growing 10 times as fast as the economy that trade, adjusted for growth, at a discount to the broader market are very good bets. So the analysis stands even as the numbers are corrected.