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A Net to Get Caught Up In

A year ago, Internet stocks were the dateless, unwanted dweebs of the high school prom. But like a good Mom, BusinessWeek said their day would come. Last August, we rolled out the Real-World Internet Index and told investors these Web companies were worth a shot. Our mailbag said we were crazy. But on the RWII's one-year anniversary, we have a verdict: The index is up a sizzling 71.1% through Aug. 15, mocking the 6.6% gain in the Standard & Poor's 500-stock index.

Now investors have a Sex and the City-worthy lament about Net stocks: Are all the good ones taken? After all, 7 of the 20 original RWII companies have been acquired. Barry Diller's InterActive (IACI) bought four: Expedia, LendingTree (TREE), Ticketmaster, and Among those remaining independent, valuations are high, especially for high-profile names like eBay (EBAY) and Five have risen 125%-plus since last August, with low-cost Web access provider United Online's 208% gain leading the way.

The good news: There are more worthy Net stocks where those came from. None is quite the company that, say, recently acquired Web travel agency Expedia is. And collectively, common sense says you can't expect the RWII to rise another 71% by next August. But the new stocks we're adding are bets on long-term trends that drive growth and trade at reasonable multiples of earnings. Yes, earnings. You don't get into this Net index without them.

HERE ARE THE NEW ADDITIONS: (PCLN) replaces in the index. Still the leader in deep-discount travel, Priceline has cut costs and is set to make consistent profits. Travel booking is moving online fast, and Priceline is both exploiting its name-your-own-price model and selling cheap travel using conventional pricing. The stock is pricey at 78 times this year's profits, but restructuring will let profits rise much faster than sales. Priceline is also a good buyout candidate.

Ameritrade (AMTD) the online stockbroker, takes the place of Web-savvy mortgage lender IndyMac Bancorp (NDE) for a simple reason: The stock market is picking up while the mortgage market cools. Earnings per share for the first nine months of its fiscal year, through June, rose 138%. Revenues rose 64%, thanks largely to customers Ameritrade gained through last year's merger with rival Datek, while costs rose only 33%, thanks to merger-related efficiencies.

Symantec (SYMC) substitutes for Network Associates(NET). Both are direct competitors in the virus-protection business, but Network Associates has had trouble executing, leading to a 95% drop in second-quarter profits and making Symantec a better pick. (FWHT) replaces Overture Services (OVER) its larger rival in the pay-per-click advertising business. Like Overture, FindWhat sells online ads tied to search-engine results. Advertisers like the model because they're only charged if surfers click on the ad to visit their site. FindWhat is a buyout candidate, but as an independent, its price-earnings ratio of 44 on this year's earnings is cheap by Net standards -- and compared to projected 71% annual profit growth over five years. Overture is being acquired by Yahoo!.

Subbing for LendingTree is Digital Insight (DGIN), a software company whose products power banks' Web banking services. With a price-earnings ratio of 37 on this year's earnings and projected five-year profit growth of 30%, it can grow with the online-banking market.

Monster Worldwide moves into the slot occupied by e-tailer Alloy Online (ALOY), the worst performer in the index with a 20% loss. Analysts say earnings will grow nearly 50% next year on just a 9% sales gain, which makes sense for a tech-driven employment-advertising service in a recovering economy. Our worry is its p-e ratio of 65 on 2003 earnings. Finally, we add E*Trade Group to replace Intuit. Intuit sold its online mortgage business to focus on software.

The RWII was set up to be a conservative way to play the Net. In this year's market, you actually made bigger gains on stocks that had fallen hard since 2000, like Priceline, FindWhat, online entertainment player RealNetworks (RNWK) or Web-infrastructure company VeriSign (VRSN). We rejected them all last year in favor of safer names like IndyMac and cash-rich (RCOM); VeriSign and RealNetworks are still too fundamentally shaky for this index. Our goal was to identify those Net stocks that were about to post hefty earnings gains without betting wildly on companies that are still struggling to turn a profit. That's what the index did -- and ought to do again. By Timothy J. Mullaney

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