Internet stocks have a reputation for delivering explosive growth. But having millions of users doesn't always translate into big profits or attractive shareholder returns.
Today I'll look at two UK internet stocks with high profit margins and serious growth potential.
Annoying but profitable
We all love to hate opera singer Gio Compario, who has featured in most of the TV adverts produced by Gocompare.com Group (LSE: GOCO), but he seems to be helping the firm to sell its product. Gocompare.com was spun out from insurance group Esure in November 2016. The group published its first set of results as a standalone company on Thursday.
The figures were broadly as expected, with revenue up 19.5% to £142.1m. After stripping out the one-off costs of the firm's listing, adjusted operating profit rose by 29.9% from £23.1m to £30m. Adjusted earnings rose by 23.9% to 5.7p per share, putting the stock on a trailing P/E of 16.8.
Gocompare only joined the stock market in November, after it had paid £85.8m of dividends to its former parent. Shareholders won't receive a dividend for 2016 but the group is targeting a payout ratio of 20%-40% of earnings in the future. Taking the mid-point of this range and applying it to last year's earnings would give a yield of about 1.8%.
That's not a very high yield
There are a couple of obstacles which could prevent the group being more generous to shareholders for the next couple of years. The first is that it took an £85m loan to fund its final dividend to Esure before it floated. This was down to £54.7m by the end of 2016 and should continue to fall steadily.
The other problem is that it's clearly number two in the price comparison sector. In my view, Gocompare.com is like Zoopla, whereas rival Moneysupermarket.com Group (LSE: MONY) is like Rightmove.
The firm's management seem to agree. Gocompare is planning to "deploy capital during 2017 on investments that will drive shareholder value". Translated, I think this means that management is hoping to make some acquisitions this year.
Is bigger better?
Gocompare reported an adjusted operating margin of 21.1% for 2016. That looks low compared to Moneysupermarket's figure of 34.1%.
However, it's possible that it will grow faster than its larger peer. Moneysupermarket's earnings growth has slowed over the last two years. The group's adjusted earnings per share only rose by 8% last year, compared to 23.9% for Gocompare.
Moneysupermarket isn't any cheaper, either. The FTSE 250 group's shares trade on a 2017 forecast P/E of 19.5, compared to 16.5 for Gocompare.
This is the kicker
Which stock would I buy? Personally, I'd buy Moneysupermarket because the firm's shares offer a higher forecast yield, at 3.3%. I also like firms which have no debt and sector-leading profit margins. But Gocompare may well outperform in terms of outright growth.
And here's the thing. According to Gocompare, only 7.4% of households use price comparison for their home insurance. For motor insurance, the figure is 23.3%.
These figures suggest to me that the price comparison sector still has a lot of growth potential. I suspect that both companies will deliver decent returns for shareholders over the next few years.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Moneysupermarket.com and Rightmove. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.