My Top Internet Software & Services Stocks For 2016

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Includes: AKAM, CMPR, CSGP, CSOD, CTCT, CVT, DWRE, EBAY, EGOV, ELNK, ENV, FB, GOGO, GOOGL, GRUB, GTT, JCOM, LNKD, LOGM, MELI, MKTO, P, QTWO, RATE, RAX, SCOR, SINA, SOHU, SSTK, STMP, TWTR, VRSN, WBMD, WIX, YELP, YHOO, YNDX, Z
by: Stan Stafford

Summary

In this series of articles, I will be reviewing individual industry sectors and selecting my favorite stock picks for 2016.

For this article, I will be reviewing the Internet Software & Services industry, taking a look at revenue/earnings growth and the overall financial stability of the included companies.

Out of this group of stocks, my top picks are Alphabet and Rackspace Hosting.

Overview

In this series of articles, I will be taking a look at various industry sectors and selecting what I believe will be outperforming stocks for 2016. For the first article, I reviewed the Airline industry and made my top picks for this year. In this article, I will review the following Internet Software & Services stocks:

  • Akamai Technologies (NASDAQ:AKAM)
  • Alphabet (NASDAQ:GOOGL)
  • Bankrate (NYSE:RATE)
  • Cimpress (NASDAQ:CMPR)
  • ComScore (NASDAQ:SCOR)
  • Constant Contact (NASDAQ:CTCT)
  • Cornerstone OnDemand (NASDAQ:CSOD)
  • CoStar Group (NASDAQ:CSGP)
  • Cvnt (NYSE:CVT)
  • Demandware (NYSE:DWRE)
  • EarthLink Holdings (NASDAQ:ELNK)
  • EBay (NASDAQ:EBAY)
  • Envestnet (NYSE:ENV)
  • Facebook (NASDAQ:FB)
  • Gogo (NASDAQ:GOGO)
  • GrubHub (NYSE:GRUB)
  • GTT Communications (NYSE:GTT)
  • J2 Global (NASDAQ:JCOM)
  • LinkedIn (NYSE:LNKD)
  • LogMein (NASDAQ:LOGM)
  • Marketo (NASDAQ:MKTO)
  • Mercadolibre (NASDAQ:MELI)
  • NIC (NASDAQ:EGOV)
  • Pandora Media (NYSE:P)
  • Q2 Holdings (NYSE:QTWO)
  • Rackspace Hosting (NYSE:RAX)
  • Shutterstock (NYSE:SSTK)
  • SINA (NASDAQ:SINA)
  • Sohu.com (NASDAQ:SOHU)
  • Stamps.com (NASDAQ:STMP)
  • Twitter (NYSE:TWTR)
  • VeriSign (NASDAQ:VRSN)
  • WebMD Health (NASDAQ:WBMD)
  • Wix.com (NASDAQ:WIX)
  • Yahoo (NASDAQ:YHOO)
  • Yandex (NASDAQ:YNDX)
  • Yelp (NYSE:YELP)
  • Zillow Group (NASDAQ:Z)

Step 1

The first step I took to narrow down the list of possible options was to look at the earnings over the past five years of these stocks within the industry sector. I removed any stock that had negative or flat (less than 2%) earnings growth during this time. These stocks included:

  • Bankrate - (115% decline)
  • ComScore - current negative earnings
  • Cornerstone OnDemand - current negative earnings
  • CoStar Gruop - (153% decline)
  • Cvent - (266% decline)
  • Demandware - current negative earnings
  • EarthLink Holdings - (179% decline)
  • Gogo - current negative earnings
  • GTT Communications - (560% decline)
  • LinkedIn - (1.06K% decline)
  • LogMein - (39.5% decline)
  • Marketo - current negative earnings
  • Pandora Media - current negative earnings
  • Q2 Holdings - current negative earnings
  • Shutterstock - (27.7% decline)
  • Sohu.com - (124% decline)
  • Stamps.com - (29.1% decline)
  • Twitter - current negative earnings
  • VeriSign - (38.2% decline)
  • Wix.com current negative earnings
  • Yahoo - (70.3% decline)
  • Zillow Group - (7.15K% decline)

Step 2

I then took the list of remaining stocks and checked the revenue growth of each over the past two years. I am removing any stocks that had flat revenue growth (less than 2%) or a decline in revenue over the past two years. These stocks include:

  • Yandex

Step 3

My next move was to examine the trailing PEG ratio of each of the remaining stocks. I removed any stock that had a PEG ratio over 2x to focus more specifically on fairly valued/undervalued stocks. These stocks included:

  • Akamai Technologies - 5.17x
  • Envestment - 6.74x
  • Facebook - 15.04x
  • j2 Global - 2.07x
  • NIC - 2.63x

Step 4

The next set of data I reviewed was the Fundamental and Value Scores for each of the ten remaining stocks. These scores are calculated by YCharts and I have found them to be very useful when researching investment options. More details on each of the scores can be found here and here.

Fundamental Score Value Score
Alphabet (Google) 9 2
Cimpress 8 2
Constant Contact 8 2
eBay 9 4
GrubHub 7 2
Mercadolibre 9 2
Rackspace Hosting 9 3
SINA 8 2
WebMD Health 6 2
Yelp 7 2

To determine the best stocks for 2016, I'm only taking into consideration stocks that have combined scores of 10 or higher. Doing this left me with the following remaining stocks:

  • Alphabet
  • Cimpress
  • Constant Contact
  • eBay
  • Mercadolibre
  • Rackspace Hosting
  • SINA

Step 5

My next step was to look at the book value of each company and to remove any stock that has seen a decrease in its book value over the past five years. Cimpress was the only stock to have seen a decline in book value during this time period.

CMPR Book Value (Annual) Chart

CMPR Book Value (Annual) data by YCharts

Step 6

I then looked at the remaining stocks and only included stocks with earnings yields of 3% or higher in my final analysis. Stocks with earnings yields under 3% include:

  • Constant Contact - 1.95%
  • Mercadolibre - 2.27%
  • SINA - 2.26%

Step 7

My next step was to look closer at each stock remaining that passed all previous criteria and determine whether or not there were any reasons to eliminate them as great stock candidates for 2016. In doing so, I reviewed the financials of each company, the most recent quarterly report transcripts, and searched for any news items that warranted concern.

Alphabet (Google)

For its last quarter, the company posted a 17.8% increase in revenue and an increase in earnings per share from $6.88 to $8.67 compared to the same period prior year. It was a strong quarter for the company that continues to improve its cash position and remain solid financially with appropriate debt levels.

Core performance increased significantly with a segment revenue increase of 18% compared to prior year numbers. With paid clicks performing well and the company enjoying lower capital expenditures and an attractive tax rate, the company appears poised to see increased price appreciation this year.

The stock is currently down just over 2% YTD, but it has risen significantly (over 8%) during the past two months. I look for this trend to continue throughout the year as I believe the company will continue to show strong quarterly results.

eBay

For its last quarter, the company posted a decline in earnings per share from $0.90 to $0.50 and revenue that was flat compared to the same period last year. With the exception of StubHub, which saw strong performance, there isn't much to get excited about in terms of eBay's short term potential.

The company issued soft guidance for Q1 and full year revenue that was well below consensus estimates. This along with a growing perception that eBay sellers continue to be dissatisfied with the company and its policies. I believe the company has the potential to turn things around, but I don't think there will be any significant price appreciation for the stock this year. And without necessary steps from management to improve MarketPlace, the long term potential of the company remains limited.

Rackspace Hosting

For its last quarter, the company posted an increase in earnings per share from $0.26 to $0.31 and a 10.7% increase in revenue compared to the same period prior year. It was a strong quarter that was somewhat handcuffed by soft sales guidance.

The company ended the year with $485M in cash and $492M in debt, which is far from ideal. However, there has been recent news to get excited about in terms of the company's future potential. In addition to continued buyout rumors, Rackspace recently joined with Google to co-develop an open server design.

Rackspace has seen its stock price swing wildly over the past year. It has seen a 53.7% decline in its price over the past 52 weeks, but YTD the stock is only down 5%. The stock has performed nicely over the past two months, but the question is which trend will continue throughout the reminder of 2016.

RAX Chart

RAX data by YCharts

RAX Chart

RAX data by YCharts

RAX Chart

RAX data by YCharts

I believe that Rackspace will continue to improve its annual revenue through its increased market presence and focus on improving sales/marketing execution. Managed hosting spending is estimated to grow 9% annually through 2019 which bodes well for the company. The company's shift of resources toward its higher growth products does pose some risks, but I think the upward potential is far greater.

Conclusion

Out of this group of stocks, my top picks are Alphabet and Rackspace Hosting. I believe that Alphabet is performing well on nearly all cylinders and should continue its impressive stock performance throughout the remainder of 2016. Rackspace Hosting does have some challenges, but I believe at its current price, the stock is positioned nicely to see increased appreciation in the near term.

As always, I suggest individual investors perform their own research before making any investment decisions.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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