How The Web 20 Whipped The Street

Out-of-favor companies helped it blow past the S&P 500

Since we revised the BusinessWeek Web 20 on Apr. 15, our portfolio of blue-chip Net stocks has gained 20%. That's almost triple the 6.9% rise of the Standard & Poor's 500-stock index and eases past the 15% hike in the Amex InteractiveWeek Internet index.

The 3-year-old Web 20 beat the market by holding on to out-of-favor companies. The biggest gain, 58% since April, came from ad agency aQuantive (AQNT ), which we stuck by as it struggled to absorb its 2004 acquisition of Razorfish. This year, Razorfish's creative savvy added to aQuantive's media buying and technological prowess grabbed more business from two dozen existing clients and nearly doubled first-half pretax profits. We also hung on to eBay (EBAY ), (AMZN ), and e-jeweler Blue Nile (NILE ) when e-tailers took an earnings hit. They rewarded us with strong second quarters. Google (GOOG ) rose 48%, too.

But the fun part of keeping the Web 20 is learning from mistakes. We dropped online broker Ameritrade (AMTD ) because of low NASDAQ volume and DVD-by-mail provider Netflix (NFLX ) because competition from Blockbuster's (BBI ) online service forced price cuts that sapped profits. Bummer. Netflix scored a fast turnaround as Blockbuster struggled, and Ameritrade got a takeover bid from rival E*Trade Financial, which it rejected. Netflix and Ameritrade both soared 80%. Meanwhile, newcomers InfoSpace (INSP ), an online advertising play, InPhonic (INPC ), whose site lets consumers compare wireless phone plans, and realtor ZipRealty (ZIPR ) all tanked.


In our latest round of Web 20 adjustments, Infospace goes after two weak profit reports. We also cut (PCLN ), E*Trade (ET ), Chinese Web portal Sina (SINA ), and (SHOP ), a price-comparison site being sold to eBay. We still like InPhonic and ZipRealty. InPhonic has had trouble digesting an acquisition, but CEO David Steinberg says it's closing duplicate facilities and ending unprofitable contracts. At 21 times 2005 estimates, with profits forecast to grow 30% a year, it's a bet that we'll let ride. ZipRealty, set to top $100 million in revenue and $10 million in pro forma profits this year, is on track.

Among our new picks we're welcoming back Netflix. It's pricey at 64 times this year's estimates, but it has room to cut marketing costs and raise prices as Blockbuster's threat recedes. We think Expedia (EXPE ), which IAC/InterActiveCorp. (IACIO ) just spun off, is a better travel play than Priceline. Merrill Lynch (MER ) says Expedia will generate 2005 cash flow of $740 million -- putting its value around 10 times cash flow -- despite problems at its unit.

IAC/InterActiveCorp owns everything from home shopping network HSN to But watch two big growth sources: search engine Ask Jeeves and loan-referral service LendingTree. Jeeves will vie for $4 billion in advertising that consultants from the Kelsey Group in San Francisco say will move online by 2008 from print Yellow Pages. IAC's financial-services unit tripled first-half profits by boosting lending and real-estate referrals.

We think the next big Net wave is reengineering health care, so we like Quality Systems (QSII ), which makes software for doctors' offices. Even after jumping to 65 a share from 25, QSI trades at a p-e of 40 -- not bad, considering expected 30%-a-year profit growth. Our last pick is Audible (ADBL ), a purveyor of downloadable spoken media such as audio books. Analysts think 2006 profits will rise sixfold, making Audible a reasonable speculation even at 31 times 2006 estimates.

If there's a lesson in the Web 20's performance, it's this: Stick to your guns. This time, we're even more prepared to ride out the rough patches with companies that are fundamentally sound.

By Timothy J. Mullaney

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