Internet Chart of the Week:Internet Large Caps Dominating Small Caps in 2015

Intro — Citi’s Internet Index has returned ~44% YTD and is outpacing the S&P 500by 4,300 bps. Although this performance is robust and suggests that the Internetsector is broadly having a strong year, when digging into the data, it is clear thatmost of this performance has been driven by a select group of large-caps, withSMID-caps notably underperforming. That’s why in this week’s Internet Chart of theWeek, we explore the divergence between these two groups and offer our thoughtson the contributing factors leading to this outcome.

    The Charts — As shown in Fig. 1, Citi’s market-cap weighted Internet Index hasclimbed by 44% YTD (vs. +1% for the S&P 500). Clearly the Index has had a strongyear, but as shown in Fig. 2, almost all of this outperformance is due to theappreciation of large-cap stocks (AMZN, FB, GOOGL and NFLX) and by multipleexpansion (Fig. 3). Indeed, the average large-cap Internet stock has appreciated byover 22% in 2015, while the average SMID-cap name has declined by 10%. Despitethe outperformance by large caps, we continue to recommend AMZN, FB, andGOOGL, as all three are benefitting from network effects and are consolidatingmarket share in their respective industries (see our note The Big Are GettingBigger), and in the case of AMZN and GOOGL are realizing operating leverage andexpanding margins. In the SMID arena, we recommend names where we believesentiment is overly negative and where valuations are largely already washed out,such as YELP, TUBE and GRUB as well as GDDY. We’ve also seen a recent pickupin M&A in the SMID space (e.g., AOL, ZU, CTCT, KING, etc.) and this couldcontinue to be a driver among select strategic SMID-caps.