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How to invest in the global Internet

International markets may see faster growth, and could offer attractive valuations.

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This summer, investors are getting geared up for Chinese e-commerce company Alibaba’s listing on the New York Stock Exchange. Alibaba is a big deal; last year the company processed more than 11.3 billion orders, worth more than $248 billion, which was more than Amazon and eBay combined. But while Alibaba is getting all the headlines, it is just one of many potential opportunities tied to growing Internet usage outside the U.S.

Even after decades of growth, the Internet remains a key theme for investors today. International Internet companies may be particularly interesting, because compared with the U.S., some foreign markets are on track to expand Internet use more rapidly. Foreign markets may also offer unique local opportunities, and are home to stocks that trade at a valuation discount compared with U.S. peers.

“I think we can all agree that the Internet will continue to take share from traditional commerce,” says Sammy Simnegar, manager of Fidelity Emerging Markets Fund (FEMKX) and Fidelity Global Capital Appreciation Fund (FIVFX). “But in terms of e-commerce, you have to be very particular about who you invest with, because most of the stocks of the direct Internet companies are very expensive. They may be winners, but are they worth the price?”

Asia poised for rapid growth

Anyone who watched the rise of leading Internet stocks in the U.S. may wish they could go back in time to invest when those companies were cheaper. That’s obviously impossible, but it may be possible to find countries where Internet usage levels are growing at a trajectory similar to that which the U.S. experienced in recent years—potentially providing a powerful tailwind for online retailers.

Portfolio manager Bill Kennedy, who runs Fidelity’s International Discovery Fund (FIGRX), says he is focused on Asia for the most attractive growth prospects. “I would imagine that e-commerce in the less developed countries in Asia could grow at more than 20% for a number of years, and in more developed Asian markets at around 15% for the next couple of years,” says Kennedy.

Investors may be able to take advantage of the trend by buying companies with direct exposure to fast-growing markets. For example, Kennedy’s fund has invested in Rakuten (RKUNY), the largest Japanese online retailer. “Online shopping in Japan really didn’t take off until the smartphone,” says Kennedy. “But since then, it has exploded and retailers have benefited —but penetration levels still haven’t caught up with the U.S.”

Rakuten has recently traded at a steep discount to the leading Internet retailers in the U.S.; Amazon recently traded around 55 times earnings, while Rakuten traded in the mid-20s.

China is another example of a market with strong growth projections, though Kennedy cautions that valuations there have gone up significantly. Alibaba has been a major beneficiary of the growth of online retail in China, where auto congestion, pollution, and tech savvy young consumers make online shopping particularly desirable. Kennedy has invested in Alibaba through Softbank (SFTBY), which holds a major stake in the company.

On the other hand, opportunities in Europe tend to be more idiosyncratic. “The environment in Europe tends to be more competitive, with global companies, lower margins, and less of a runway to growth,” says Kennedy. “So while I have some niche investments in European Internet stocks, in general I am biased toward Asia.”

First movers at lower prices

A key advantage for Internet companies comes from the network effect—the ability to establish a large user base that acts as a competitive advantage. The interesting thing about non-U.S. Internet companies is that shopping for first movers in less developed Internet markets may provide something of a price break.

“Once a business has the most eyeballs, the most sellers, and the most buyers, everyone congregates there and they have lots of pricing power—it can be a great competitive advantage,” says Simnegar. “But because international investors are more price conscious in general, and U.S. investors might not be as focused on international options, you may be able to invest in these industry leaders at a lower valuation.”

As an example, Simnegar mentioned real estate Web sites. In the U.S., Zillow (Z) is the most popular real estate site. But you have to pay up to invest—shares in the company trade north of $120 a share, despite having net losses in each of the first two quarters of 2014. Simnegar says foreign equivalents trade at much more attractive prices. For instance, Rightmove (RTMVF), the most popular real estate site in the U.K., trades below 20 times trailing earnings, and top Chinese site SouFun (SFUN) trades at around 12 times earnings.

“In the U.S. when there is a certain megatrend, everyone jumps in there and it gets expensive fast,” says Simnegar. “Internationally you may be able to buy a stock cheaper.”

Unique solutions

While global powerhouses and rising usage provide two ways to tap into Internet opportunities beyond the U.S., another approach is to focus on smaller companies with niche solutions that work in local markets. These opportunities may not have the global scale of some retail operations, but can still make for significant opportunities.

Kennedy points to companies like an online grocer in the U.K. that took advantage of the dense population centers in England to make grocery delivery a successful business. “You can’t export something like that to the American Midwest, but it works in London, and has been a great investment. People have different ways of accessing the Internet, may form different demographics, or have different lifestyles, and so what may work in one part of the world may not necessarily work in another.”

New markets, same dynamics

While international Internet investments may hold some appeal, they are not without risks. If you are considering investing in stocks tied to this trend, we think it makes sense to do so within a diversified investment strategy built around your individual goals, time frame, and risk tolerance. You should also be aware that investing in different markets may introduce currency risks and regulatory differences. What’s more, tech companies everywhere have the potential for volatility. In the short term, even foreign Internet stocks tend to show some correlation to the NASDAQ. As an example, many Internet-related foreign stocks sold off in April and May along with U.S. growth stocks.

Still, there may be reasons to consider this part of the market. Kennedy says, “If you take a step back and look over a five-year time horizon, a number of the companies in this space have the potential to outperform their NASDAQ peers, given that they have been growing faster and are expected to continue that growth longer, particularly the Chinese companies.”

Learn more

  • Sammy Simnegar manages Fidelity International Capital Appreciation Fund (FIVFX) and Fidelity Emerging Markets Fund (FEMKX)
  • William Kennedy manages Fidelity International Discovery Fund (FIGRX)
  • Find out about international trading at Fidelity
  • Discover individual stocks, ETFs, and mutual funds in our research center
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Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information.  Read it carefully.

Views expressed are as of the date indicated and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author, as applicable, and not necessarily those of Fidelity Investments.

Investing involves risk, including risk of loss.

As of April 30, 2014, Fidelity International Discovery Fund held 1.3% of net assets in SoftBank Corp. and 0.649% in Rakuten, Inc.
As of April 30, 2014, Fidelity Capital Appreciation Fund held 0.763% of net assets in SoftBank Corp., 0.392% in Rakuten, Inc., 0.360% in Rightmove PLC, and 0.292% of SouFun Holdings LTD.

Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.

Past performance is no guarantee of future results.

Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. These risks are particularly significant for funds that focus on a single country or region.
As with all your investments through Fidelity, you must make your own determination whether an investment in any particular security or securities is consistent with your investment objectives, risk tolerance, financial situation, and your evaluation of the security. Fidelity is not recommending or endorsing this investment by making it available to its customers.
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