Two of the best companies among the S&P/ASX 200 (Index: ^AJXO) (ASX: XJO) that offer investors the opportunity to profit from the growth of the global digital economy are SEEK Limited (ASX: SEK) and REA Group Limited (ASX: REA).
Over the past five years the two businesses are up 171% and 407% respectively, as both continue to harness the global migration of eyeballs and advertising dollars online.
The profit growth of digital businesses is unlikely to halt over the next five years, but this is a competitive space that will produce winners, losers, and the odd fortune maker.
So let's take a look at the merits of SEEK v REA Group for growth-oriented investors given current valuations.
Management:
Both businesses appear to possess excellent management teams and CEOs that are focused on long-term development. Given the growth of powerful U.S. companies, online advertising is not a space you can stand still in, but both companies appear focused on widening their network effects and competitive positions. This factor would have to be a 0-0 draw in my eyes.
Competition:
Although SEEK is in the business-to-business recruitment space it is facing real competition from networking giant LinkedIn that threatens to take market share from paying advertisers. It is also facing competition from Indeed.com's pay-per-performance advertising model it charges employers.
SEEK though still believes it offers a superior return on investment to employers via its "jobs board" approach, compared to LinkedIn's social network. It is also possible that one day SEEK could link to integrate with the likes of LinkedIn for example.
In Australia, REA Group operates in a duopoly with Fairfax Media Limited's (ASX: FXJ) domain.com as its only real rival in a lucrative market. As such REA Group appears to have a stronger competitive position. Therefore, REA Group goes 1-0 up.
Yield
You don't buy these businesses for income, but REA Group recently paid out 81.5 cents per share on earnings of $1.52 per share, which represents a 53% pay out ratio. SEEK paid out 40 cents per share in dividends on earnings of 50.9 cents, which represents a payout ratio of 80%.
Historically and most likely going forward SEEK has offered investors a moderately higher yield, but REA Group retains more profits to invest for growth. As such REA Group wins and goes 2-0 up.
Valuation
Given shares are changing hands for $16.98, I'm not keen on SEEK's valuation with flat growth rates recently as it reinvests heavily to protect and grow its market share given the rising competitive threats.
SEEK earned 50.6 cents in earnings per share in FY 2016, which places it on 33x trailing earnings, but analysts have some aggressive looking consensus estimates of 66 cents in earnings per share for FY 2018. If this double-digit compound growth was achieved it would place SEEK on around 26x FY 2018's estimated earnings.
Given its growth rates (after all the reinvestment) SEEK shares look expensive to me.
REA Group however trades on around 33x analysts' estimates for earnings per share of $2.06 in FY 2018, although these estimates are likely to edge higher on news the company is moving into the mortgage broking space.
REA Group has also been growing at consistent double digit rates, despite low property listing volumes over the past two years. Moreover, this spring/summer should see a flood of property come to market given the almost certain end of the rate cutting cycle, with REA boasting several other growth avenues on the horizon.
Result
I think it's easier to justify REA's valuation on today's prices and therefore it's 3-0 to REA Group in a clear victory.
SEEK is still a good business, but not as good a risk-adjusted investment prospect based on today's valuations in my opinion.
If you don't fancy SEEK or REA Group, you might prefer a stock that pays a far bigger yield and also boasts some overseas growth prospects..
