When we look back 20 years from now, I believe the Internet will be regarded as one of the greatest technological advances in the history of man. This may be stretching it somewhat, but the Internet really has, in less than a decade, become an integral part of everyday life.
It is not a fad. It will not go away. And if you want to make money, you need to have some exposure to the Internet sector. Did you know, for example, that the AMEX Internet Index is up over 16% since mid-April?
Momentum stocks like megalith search engine Google Inc. (NASDAQ/GOOG), which I have discussed in previous commentaries, continues to hold near the $300 level, with a market-cap of a whopping $82 billion and trading at 40 times its estimated FY06 earnings. The company’s PEG looks expensive at 1.84, but, given the company’s superlative growth, it may not be that out of line. That said, you still need to be careful here, as the company will need to continue to blow away estimates in order to deserve its rich valuation.
Google’s recent Q2 showed a hint of a slowdown. While the company earned a record quarterly $1.36 per diluted share, it only beat the average Street estimate by $0.15 or 12.4%. Compare this to the Q1 when Google beat the Street by a whopping $0.37 a share or 40.2%. In fact, the 12.4% outperformance is the most disappointing since the company launched its initial public offering back in August 2004. While the earnings trend is consistently higher, this will not be enough to satisfy momentum investors, who, at the end of the day, will continue to want to see consistent blowout quarters. As Google grows, growth rates will clearly be more difficult to attain.
Already for FY06, the average Street estimate calls for Google to earn $7.25 per diluted share, a quarterly average of $1.81, which is 33% higher than the recent $1.36 earned in the Q2. If there is any hint of a slowdown, momentum stocks such as Google could see a major selloff. My concern with Google is that its current revenue model is solely dependent on advertising, and this is risky.
If Google can maintain its extraordinary growth, the stock would easily be at the top of my Internet list, ahead of more established companies like Yahoo! Inc. (NASDAQ/YHOO), eBay Inc. (NASDAQ/EBAY) and Amazon.com Inc. (NASDAQ/AMZN).
If you’re feeling a strong urge to trade momentum stocks, just make sure you either have stop-loss limits in place or buy put options to hedge the downside risk from a potential meltdown.