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Four Key Dynamics Driving Online Growth

By Will Craig
Equity Analyst

There’s no doubt that the Internet has altered modern-day life, from the way we shop and travel to how we do our jobs and communicate with friends. But as seismic as these shifts have been, they may only be an opening act for what’s coming next. Rapid technological advances, coupled with the inexorable pull of cultural and demographic forces, make it likely that the Internet will have a more profound economic and societal impact in the next decade than it has had in the last.

These trends bode well for Internet businesses, especially large companies with brand names and formidable market share. Despite the seeming pervasiveness of the electronic world, digital penetration is relatively modest in many areas. Only one in 10 products, for example, is bought online, while only half of all travel bookings are electronic. These rates will expand significantly in coming years. In fact, the earnings of Internet companies are projected to grow three times faster than the S&P 500 over the next five years. Though the prospects are bright for well-placed smaller companies, the outlook is especially encouraging for larger businesses with vast troves of data, top engineering talent, sturdy balance sheets and global reach.

Investor enthusiasm has powered Internet-related stocks higher in the past year, especially in recent months. That has pushed the weighting of the U.S. technology sector to its highest level since the dot-com boom of the late 1990s, raising concerns about potential overvaluation and the risk of a snapback. It’s certainly true that Internet stocks have above-average volatility, and there is always the risk of a sharp downdraft on the heels of a prolonged rally. But over the long term, there are many promising factors that are likely to propel Internet companies, and I remain extremely optimistic about their outlook.

While many trends will shape the online world and the prospects of Internet businesses in coming years, here are four that I believe are particularly noteworthy.

Only half of the world’s population is on the Internet.

The most basic dynamic is that Internet usage will keep expanding beyond the more than 3.5 billion people who are online today. Not surprisingly, growth is being paced by economic expansion in the developing world and the increased availability of smartphones in remote areas. But there’s a less obvious factor: a tilt in consumer preference toward smartphones with larger screens over the pocket-size models that were once favored.

One estimate predicts that large-screen phones will make up 30% of the mobile market by next year, up from just 8% in 2014. Bigger screens spur Internet usage by making websites easier to see and interact with. A larger surface area also gives Internet companies more digital real estate on which to display ads.

Advertisers want to see when — and where — you make purchases. 

Along the same line, online advertising is likely to rise as companies see its benefits. Only one-third of ad dollars are spent online even though half of all media consumption is digital. That stems partly from the ingrained habits of advertisers. But this is changing, and I expect online penetration to reach 50% in the next few years and ultimately hit about 75%.

This shift will be hastened by measurement capabilities allowing websites to prove their effectiveness. It’s easy to show that a web user clicked an ad and bought a product. But increasingly, geolocation and other advanced tools make it possible to prove that a consumer saw an ad and bought an item, even if the purchase occurred in a physical store weeks after the ad was seen.

Social networks are becoming a far larger presence in daily life.

Social networks on which users communicate with friends already have begun to overtake other forms of communication, even email and phones. The popularity of social platforms among so-called Generation Z — people up to 20 years old, who form the largest U.S. population segment — will cause that dynamic to soar. This is an example of how “digital natives,” young people for whom typing on a keyboard is as instinctive as putting pen to paper, will shape technology.

Artificial intelligence is making tremendous strides.

Artificial intelligence and machine learning already exist — for example, anytime a website recommends products based on your buying habits. But this will pale in comparison with what comes next. For instance, few innovations have been as far-reaching as online search engines. It’s hard to remember a time when we couldn’t dig up even the most arcane facts with just a few keystrokes. But the day may arrive when we no longer type queries into a search engine. Instead, we’ll simply ask a question of our phone or an electronic device placed atop a household table, and it will promptly tell us the answer. The devices may become so skilled that they know us almost as well as we know ourselves.

Throughout the history of the Internet, fast-growing start-ups have been at the center of the action. But many forces driving the industry today appear to favor bigger companies. Though it’s relatively inexpensive to launch a website, it’s challenging to draw consumer interest and wrest market share from dominant players. Though periodic sell-offs are likely to affect the sector, the long-run prospects of leading companies are promising. 

WLMC 2011

Will Craig is an equity analyst who covers e-commerce and online advertising. Based in Los Angeles, he has 10 years of investment experience and has been with Capital Group since 2011.

The above article originally appeared in the Summer 2017 issue of Quarterly Insights magazine.