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Investing in e-commerce
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November 18, 1999: 6:00 a.m. ET
Landing winners a challenge in fledgling Web retail sector
By Staff Writer Nicole Jacoby
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NEW YORK (CNNfn) - Online retailers are set to break new ground this holiday season, with Internet sales expected to set records. But those gains won't necessarily translate into big profits for investors, according to some industry analysts.
"The results for a lot of these (Internet) companies will be good from a top-line view," said Mark Cavallone, industry analyst at Standard & Poor's. "But I don't know that it follows that the stock will necessarily perform better."
Profits -- not revenue -- tend to drive share prices higher, and these will continue to be absent from the books of many e-commerce companies, despite the anticipated surge in sales this fourth quarter.
In addition, because online retailers are fundamentally just retailers -- a fact commonly overshadowed by their dot.com status -- seasonal changes in sales are often a foregone conclusion. In other words, revenue fluctuations such as those that occur every Christmas almost always have been calculated into the stock price ahead of time.
"There are a lot of companies that go through seasonally strong and weak periods, but (their stocks) don't necessarily perform better or worse during these peaks and valleys," Cavallone said.
That doesn't mean investors should shrug off the holiday season altogether, though. The coming months may yield important clues about what's ahead in the online retailing sector.
Weeding out the winners
By all accounts, online retailing is still in its infancy and any purchases made by investors -- outside of day traders -- are likely for the long term.
This holiday season may help separate the serious players from the wannabes and give investors a better sense of where their dollars could be best spent.
"It's all about performance now," said Genni Combes, senior analyst at Hambrecht and Quist. "In the four to five weeks after Thanksgiving, we should get a pretty good idea of how companies are faring."
While online shopping was practically still in the experimental stage last holiday season, consumers this year will be more sophisticated and their expectations will be higher.
Companies that demonstrate they can fill and ship orders in a timely manner, provide adequate customer service and offer competitive prices are likely to fare well, analysts say.
"Obviously, companies that do better than expected will see upward movement in their stock," Combes said.
And short-term success may hint at greater things ahead.
"Either a business has good economics or it doesn't," said Peter Doyle, chief investment strategist and co-manager of the Internet Fund. "If it's not going to be good for a three-month period, it won't be good for a long period of time, and vice-versa."
Doyle's $625 million no-load Internet Fund, which focuses on networking companies and content providers such as RCN Corp., (RCNC), Marketwatch.com (MKTW)and Inktomi (INKT), has seen year-to-date returns of more than 120 percent.
Playing favorites
Despite obvious valuation and profit concerns, online superstore Amazon (AMZN) is among the companies expected to lead the pack this holiday season, especially after adding four product categories to its offerings this month.
Hambrecht's Combes also likes Barnesandnoble.com (BNBN), teen retailer iTurf (TURF), and eToys (ETYS), which she says is well-positioned to succeed this holiday season, given its current dominant position and lack of competitors aside from Amazon.
Among more traditional retailers, Gap Inc. (GPS) has its admirers.
"Those companies that have brands and that have something proprietary will do well," the Internet Fund's Doyle said.
The trickle-down effect
Looking beyond strictly e-commerce companies may be the best way to capitalize on the online retailing craze, some analysts said.
"Retailing in general is highly competitive and most companies have very poor returns on invested capital," said Doyle. "Unless you create a barrier of entry, you're never going to see very big returns."
Because their initial costs are lower than those of e-commerce companies, Internet gateways such as America Online (AOL) may be a good alternative.
"Unlike Amazon, AOL does not have to worry about shipping (or similar logistics)," said S&P's Cavallone. "They have a lot of success shuffling people to sites and they'll get a cut of the transaction or they'll just get rental fees. Either way, they'll benefit from e-commerce with high margins in the big picture."
Others are less convinced.
"As more people get on the Internet and they get more savvy and learn how to use it, they'll just go straight to the brands," Doyle predicted.
Online retailers also are creating investment opportunities outside the high-tech sector.
Shipping companies have long been expected to benefit from the e-commerce craze, as strong sales provide companies such as UPS (UPS)and Federal Express (FDX) with new and growing revenue streams.
"It makes sense that these companies will perform well," Cavallone said. "This is growth they haven't had in the past."
The same holds true of credit card and charge card companies. As more consumers shop online, the use of credit cards is expected to rise. And unlike shippers, whose newfound income may be somewhat offset by investments in staff, vehicles and other capital, the economies of scale for credit card companies are great.
"A credit card company is really just a computer," Doyle said. "There are really few physical limitations to growth."
In the end, the Internet retailing sector still remains largely undefined. With only a fraction of overall retail transactions occurring over the Web, predicting who will ultimately dominate the domain is virtually impossible.
"At the end of the day, you've got to make long-term bets in this space," Combes said. "This Christmas will be important in terms of distinguishing winners and losers, but from a market standpoint, it hasn't even started yet."
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