- In the last three years, the market valued the innovation in the internet sector at a premium over the other leading indices.
- The risk implied in the innovation is valued in higher P/E ratio, higher volatility and higher beta than ETFs tracking the other leading indices.
- Since the beginning of the year, the internet index has underperformed compared to the S&P 500 and NASDAQ 100 and the recent correction may present a good entry point into PNQI.
- Possible upcoming IPOs of trendy companies may offer additional upside to the PNQI.
Since the beginning of the internet and the dot-com bubble in the 90's, internet companies have had an image as trendy and sophisticated investments that hold a huge potential which, once unlocked, would drive the companies' stocks to the sky. Even though internet stocks' returns had many ups and downs in the last few years, many growth investors looking for high returns tend to invest in these companies in anticipation of higher returns compared with investments in large-cap companies, taking into account the greater risk that internet companies possess.
In order to check that theory, I compared, in Chart 1 below, the NASDAQ internet index performance over the last three years to the large caps indices: the S&P 500, the NASDAQ 100, and the Dow Jones Industrial Average, using leading ETFs that track these indices.
As shown in Chart 1, the PowerShares NASDAQ Internet Portfolio ETF (NASDAQ:PNQI) has yielded 89% since October 2011 and outperformed the large-cap ETFs; PowerShares NASDAQ 100 ETF (NASDAQ:QQQ), SPDR S&P 500 ETF (NYSEARCA:SPY) and SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA). The PNQI, together with the QQQ, SPY and DIA, rallied from October 2011 until July 2013, when the PNQI spiked and rose above the other ETFs.
Internet stocks yield high return thanks to the innovation they bring to the technology market. Once an internet company starts to monetize its technology, the market gives that company a premium based on the unlocked potential the company withholds that could be translated into higher revenues and earnings in the future that could drive the stock price up.
Innovation may grant one stock a premium over other stocks. However, it is coupled with risk that is expressed in high P/E ratio and high volatility. As shown in chart 2 below, the PNQI had higher P/E ratio, higher beta and higher volatility than the leading ETFs and yielded a higher return over the last three years.
As the internet sector experienced some correction at the beginning of 2014, ignoring the one-year return and expanding the comparison time frame from one year to 15 months will present the return from the point in time where the PNQI separated from the other ETFs in July 2013 and reveals that the PNQI beat the SPY and DIA and was very close to the QQQ. Except the correction at the beginning of 2014, the PNQI delivered high returns that match the risk embedded in the internet sector.
The PowerShares NASDAQ Internet Index Portfolio ETF (PNQI) yielded a higher return in the last three years over the ETFs of the leading indices: QQQ, SPY and DIA. Even though the PNQI experienced low returns year-to-date it remained a solid investment alternative for those interested to invest in the internet sector but want to minimize the risk by choosing an ETF that contains more than 100 stocks over holding one specific stock. Possible upcoming IPOs of prominent internet companies such as Box, Dropbox, Airbnb and GoDaddy will put the internet sector in the spotlight of the IPO market until the end of the year and are expected to unlock further gains in case these IPOs take place. The recent sell-off may present a good entry point into the internet sector ETF and may fit perfectly into a technology growth portfolio.
Disclosure: Information provided in this article is for informational purposes only and should not be regarded as investment advice or a recommendation regarding any particular security or course of action. This information is the writer's opinion about the companies mentioned in the article. Investors should conduct their own due diligence and consult with a registered financial adviser before making any investment decision. Lior Ronen and Finro Financial Consulting and Analysis are not registered financial advisers and shall not have any liability for any damages of any kind whatsoever relating to this material. By accepting this material, you acknowledge, understand and accept the foregoing.