E-Commerce Stocks: Hold ‘Em or Fold ‘Em?

Many years from now, when stock analysts reflect upon the history of the first dot-com boom and subsequent shakeout, how will it look?

Will the first wave of Nasdaq casualties have paved the way for even better gains and success stories later? Or will it simply be known as the beginning of the end for e-commerce stocks?

Few investors have accurate crystal balls at their disposal, and are therefore faced with a difficult dilemma. Should they get out of e-commerce stocks now and move their money elsewhere, or stay put (or get back in) when so many e-commerce stocks apparently have nowhere to go but up.

“This is a good time to start looking at [e-commerce stocks] again,” U.S. Bancorp Piper Jaffray stock analyst Safa Rashtchy told the E-Commerce Times. “We are seeing some upward trends now.

According to Rashtchy, a major downtrend is not as likely anymore. “It’s a little early, but we think we’ve seen the worst,” the analyst said.

On the other hand, Manish Shah, chief executive officer of 123Jump Network, the home of Internet Stock News, told the E-Commerce Times that he recommends staying away from e-tailers altogether.

“For the pure e-commerce retailers, there’s not much visibility in the viability of their business models or improved earnings performances, so in general they are still a bad investment,” Shah said.

From the Top

Rashtchy said that even though the hardest market drops may already be over with, investors should concentrate on those dot-coms that have the size and the established brand to succeed on a mass scale.

“There is opportunity maybe at the top end, i.e., the Amazons, and then below that, everything else is still going to be a very difficult business model,” said Rashtchy. “You need scale.”

Rashtchy also pointed to the highly specialized niche sites, such as those found in the online travel market, as potential long-term market winners, telling investors that companies “that aren’t spending a ton but have enough clientele to maintain hard margins” should be targeted.

“The broader, average e-tailers are going to have a tough time because loyalty online is still very low, even for an Amazon,” Rashtchy said. “Even Amazon has to constantly offer new specials, features, etc., to keep customers coming back, which is almost impossible for a smaller Web site.”

Sweet Spots

Though skeptical of investments in e-tailers, Shah does recommend those companies providing Internet and e-commerce infrastructure services, such as security software and database management.

“There the potential is very significant, and a longer-term investor will definitely benefit,” he said.

Shah, like Rashtchy, also pointed to the travel sector as an e-commerce area that aggressive investors can turn to for potential gains.

Shoppers and Shares

In addition to the standard cash flow/profitability metric, both Shah and Rashtchy said that customer acquisition costs are a key measurement for investors to evaluate when researching an Internet stock.

Shah also recommended that investors carefully study the market share of a company’s online segment.

“Are they increasing the market share of their niche or segment?” Shah said. “Five years ago, online brokers tried to increase market share by spending enormous amounts on advertising, but it did not lead to increased market share as a whole. All they ended up doing was taking customers from each other.”

Branding Central

Rashtchy also said to look at a company’s customer loyalty and brand, as well as its gross margin — net sales less the cost of goods sold.

“You still have to be able establish a brand,” Rashtchy said. “And how fast can they get to a reasonable gross margin of 5-10 percent?”

Shah warned that even newfound profitability can be deceiving if an investor isn’t careful.

“When these companies turn from loss-making to profitability they automatically have a P/E (price/earnings) ratio,” Shah said. “But a P/E ratio of eight or nine hundred certainly doesn’t mean it’s a good investment.”