3 Internet Stocks to Serve Different Market Niches

Victor is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Over the last decade, the Internet has opened a lot of opportunities for those who find a niche in the market and know how to make it capitalize (and monetize) it. Shutterfly (NASDAQ: SFLY), NetEase (NASDAQ: NTES) and Zillow (NASDAQ: Z) are three companies in the Internet services sector that are worth a closer look as growth prospects look promising for long-term investors.

Shutterfly: In the photo printing field 

Shutterfly is a $1.66 billion Internet-based company that has effectively managed to exploit one of the few niches remaining in the photo printing field. In addition to the company's recently-posted first quarter results that beat top and bottom-line consensus estimates providing an encouraging short-term outlook, its long-run growth prospects seem pretty promising and the firm looks poised to increase its market share. With a projected average annual growth rate of 16.67% over the next five years (consensus estimate), I'd say this stock is one to buy and hold, even with its above-average valuation.

Over 2012, total transacting customers increased by 31%, helping Shutterfly attain a 50%-52% market share. It reached its current market-leading position due to innovative products and services combined with strategic acquisitions, including Kodak Gallery online photo services and Tiny Prints, both of which contributed about 13% of extra revenue growth during 2012.

Although at first the company’s model was highly focused, it has become more diversified over time. One of the firm’s most promising initiatives is Treat, a one-to-one greeting card service, which is expected to capture a considerable portion of a $6 billion sector by offering a comfortable online service with a low price point. In order to further expand its product portfolio and gain participation in the growing mobile business, Shutterfly also purchased Penguin Digital, which also promises to drive growth in the upcoming semesters. The company is also trying to penetrate the commercial printing industry, acquiring WMSG and creating a strategic partnership with Group O to help it create a strong and successful printing business.

NetEase: In the game industry 

I believe that the Lazard Mutual Fund's recent increase in its participation in NetEase by 7% was persuaded by several factors. The most obvious was valuation; NetEase trades at 13.6 times its price-to-earnings ratio, a considerable discount to the 49.5 times the industry mean, and provides a highly attractive entry point for investors. Furthermore, the long-term growth prospects that the firm offers are pretty compelling. I’d say that investing in it should provide plenty of upside.

This Chinese company generates about 90% of its income by providing online gaming services to a market with over 350 million gamers that generated $10 billion in revenue in 2012. As the second largest in this category, its market share is substantial and constantly growing, alongside the Internet demand in the country. Further advance seems pretty likely given the firm’s high in-house research capabilities, which help them create games that continue to better adapt to changing gamer preferences and increase loyalty amongst users. Particularly, the constant development of expansion packs and innovative marketing initiatives help keep games running played and monetized, therefore increasing profits while maintaining costs controlled, thus widening its margins.

Although this firm usually develops its own games, the licensing agreement it established with Activision Blizzard for the exclusive exploitation of the very popular game, “World of Warcraft,” in China should prove highly beneficial for the company, increasing its traffic and revenue.

Although the stock price was up by about 48% since the start of the year, it´s still quite cheap. I would recommend buying this stock, especially after a strong fiscal first quarter portrayed an encouraging outlook for the upcoming quarters and long-term projections point to an average EPS annual growth rate around 13%.

Zillow: In the real estate market 

Zillow provides a complete real estate online service that includes property listing, statistics, estimates and even mortgage information. In an environment of recuperating real estate markets, this company has been riding the wave of momentum. After reporting a very strong first quarter that registered a 71% increase in year-over-year revenue to $39 million and a record in traffic of 52 million monthly unique users on mobile and Web platforms in April 2013 (up 63% year-over-year), the stock price fell by 14%; this was mainly due to concerns about high spending and competition. These shares still look pretty pricy in relation to the company´s earnings, however, so what makes Zillow a buy and hold case?

Well, the fact is that there is plenty of room for operating optimization and cost-cutting in this company and, consequently, much upside potential. For instance, advertising costs have been bulky lately -but have considerably helped drive growth- and will most likely decrease as time advances. Other products should also contribute to development; particularly, the recently-launched Zillow Digs site helps consumers to easily navigate the home improvement segment. The site is expected to generate an increased traffic that supplements the smaller number of recurring users of the core webpage who don’t buy or rent a house as often.

Furthermore, the company is currently worth under $2 billion. Since expansion opportunities abound in a market as extensive as the real estate, the firm could quickly catch up with Internet giants in other sectors, companies that are usually worth over $10 billion. In addition, a larger company such as Google or Facebook could take over Zillow soon and pay a considerable premium to stockholders. While the firm is still in a growth phase, the larger companies have the means to carry out and could widely benefit from a purchase. I would certainly bet on Zillow’s growth potential in upcoming years and buy some shares as the pullback in price opens a window of opportunity that investors shouldn’t miss.

Bottom line

Although all of the companies described above provide compelling long-run prospects, I would go with NetEase though analysts feel more bullish about Shutterfly. You might wonder why; actually, NetEase offers great growth prospects for both the short and longer term while valued well above the other companies mentioned in the report.

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Victor Selva has no position in any stocks mentioned. The Motley Fool recommends NetEase.com and Zillow. The Motley Fool owns shares of Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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