What's next for Internet stocks?

There's no valuation bubble, says T. Rowe Price's Paul Greene, though he expects an economic slowdown to mute gains.

Diana Cawfield 9 April, 2015 | 5:00PM

The digital revolution is far from over and there's good value to be had in Internet-related stocks, according to media-industries specialist Paul Greene, manager of TD Entertainment & Communications.

"It's probably not a surprise to many that the Internet is a very strong, growing area, with a lot of secular tailwind at its back," says Greene, a vice-president, analyst and portfolio manager at T. Rowe Price Associates Inc. in Baltimore. "Mobile phones have also accelerated this trend," he says, as has cloud computing. Another expanding area is social networking, "which is a fairly recent phenomenon, and will influence the business markets."

Greene predicts that Internet-related businesses will gain additional market share over the next 20 years, and that many more large companies will emerge. He cites U.S. research showing that people have been spending more and more time online.

About 30% of U.S. advertising is now done via the Internet, Greene says, adding that advertising spending on the Internet is coming close to passing television in the total amount of dollars.

Much of that advertising has been direct-marketing dollars, but Greene believes there will be substantial growth in brand promotion. "You're going to see new ways for brand advertisers to spend that money online."

TD Entertainment & Communications holds a diverse range of telecommunications, media, Internet and technology companies. Greene says he looks for companies that have strong underlying fundamentals and reasonable valuations.

"Google Inc. GOOGL, for example," says Greene, " is a company with huge market cap, it's growing a top line of 20% a year, but it's actually cheaper than the market."

Among Greene's top holdings is Priceline Group Inc. PCLN, a provider of online travel services. Its valuations are a lot cheaper now than in 1999, when Priceline had a gross profit of $50 million, says Greene. In 2012, when the stock price recovered to its pre-crash 1999 level, Priceline had $5 billion in gross profit, or 100 times more than in 1999. (All figures in U.S. dollars.) "So it tells you just how insane the valuations were in 1999 and 2000," says Greene. "We are nowhere near those levels."

TD Entertainment & Communications is categorized as a Global Equity fund because it invests in multiple sectors. But since the fund is by no means fully diversified across the broad market, Greene is often asked to address the risks of his mandate. In part, this is due to the bear market which began in 2000 and was led by plunging technology stocks.

One question frequently raised is: Are we at risk of another meltdown? "There's still a lot of value out there," says Greene, "but there are certain areas where it's getting very pricey. There's always risk. But do I think we're anywhere near the valuations that we saw in the last tech bubble. I would say no."

Even so, Greene is mindful of economic cycles that have historically played out about every seven or eight years. "We're getting along in the later stages of the growth cycle, so we should be expecting a recession in the next couple of years."

However, there's evidence that the economy has certainly repaired itself from the last downturn in 2009, and it doesn't feel like the market is overheating, says Greene. But we're also not at strong levels of GDP growth and employment.

Despite upward trends and secular growth potential, double-digit returns are not on the horizon. "The last five years has been an exceptionally strong equity market," says Greene, "and I don't think that should be used to judge what long-term returns should be. If you look at the 15-year returns of the media and telecommunications fund in the U.S., the average has been a little over 8%. That's probably more normal."

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Alphabet Inc A1,229.62 USD-0.74
Booking Holdings Inc2,031.57 USD-1.31

About Author

Diana Cawfield

Diana Cawfield  Diana Cawfield is an award-winning writer who has been a regular Morningstar contributor since 2000. Her numerous publication credits include the Toronto StarAdvisor's Edge and Chatelaine, as well as the Canadian Securities Institute's online educational services.