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Internet Stocks Are Surging... And This Is The Best Way To Profit


Investors seem to have gotten over the beating that Internet stocks took from early March to early May, when the group plummeted about 20%. Since then, these stocks have rallied nearly 17% and appear to be gaining momentum once again.

Facebook (Nasdaq: FB) has done particularly well, jumping more than 30% from a late-April low of $56 to the current price of almost $75. Following a 15% plunge to $518 in early May, Google (Nasdaq: GOOGL) has made up most of the ground it lost and now trades near $600. 

Other well-known Internet stocks have come back strongly, too, including travel agent Priceline (Nasdaq: PCLN), retail behemoth Amazon.com (Nasdaq: AMZN) and auction/e-commerce leader eBay (Nasdaq: EBAY)

Those looking to profit from the rebound have the daunting task of deciding which stocks to choose. There are many good ones, but it's hard to know which. The world of Internet investing is still relatively new and often makes little sense, with stock prices that may seem to based more on hype and unreasonable expectations than solid fundamentals.

Basically, it's just too easy to make the wrong picks and get burned, even if you do your homework. That's why in this case I think it's best to use a diversified investment that allows you to participate in the current resurgence and profit from internet stocks over the long haul.

If you agree, there's an exchange-trade fund (ETF) I strongly suggest you consider.

The fund tracks the Nasdaq Internet Index, a benchmark designed mainly to capture the performance of the largest, most liquid Internet companies listed on the three main U.S. stock exchanges. That's good because bigger tends to be safer. However, this ETF also has substantial exposure to smaller companies and leading foreign names, which I see as an advantage since smaller and foreign stocks often deliver much faster growth.

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During the past five years, the fund has crushed the market, returning 26.9% a year versus 17.6% annually for the S&P 500. PowerShares Nasdaq Internet ETF (NYSE: PNQI) has also far outperformed the broader technology sector and is in the top 1% of its category.

Of the $329 million in fund assets, 83% is in U.S. stocks and 17% is in foreign stocks. In terms of distribution by market capitalization, PNQI is 62% large-cap stocks, 23% mid-caps, 10% small-caps, and 5% micro-caps. The portfolio has 98 holdings, with the top five making up 45% of fund assets.

PowerShares NASDAQ Internet ETF: Top 10 Holdings

Thanks to pricey holdings like Facebook, Amazon, Netflix (Nasdaq: NFLX) and others, the combined portfolio has valuation metrics that are well above average. Its forward price-to-earnings (P/E) ratio, for example, is almost twice that of the typical technology fund. 

PowerShares Nasdaq Internet ETF: Valuation Metrics

Despite these high valuations and a narrow focus, PNQI hasn't been that much more risky than investments in the broader technology sector. The fund has shown roughly 15% more volatility than the average technology fund during the past three years and only about 7% more over the past five years.

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Also, despite its fantastic record, PNQI is still something of a secret. While an asset base of $329 million may sound like a lot, it's actually quite small by Wall Street standards. Many ETFs and mutual funds are far larger, often managing tens of billions of dollars.

Another sign investors are overlooking PNQI: At just under $69 a share, the fund is only trading at a 0.2% premium to net asset value (NAV). Very sought-after ETFs and closed-end funds can sometimes command premiums of 5% to 10%, and occasionally even more.

At 0.6%, PNQI's expense ratio obviously isn't dirt cheap, but it's still reasonable.

I'd be remiss if I didn't point out that PNQI doesn't hold the popular microblogging site Twitter (NYSE: TWTR) just profiled by my colleague David Sterman. The latest fund prospectus doesn't provide an explanation for the omission, which is unfortunate but certainly not fatal, as PNQI's long-term performance demonstrates.

Risks to Consider: PNQI may not be that much riskier than other technology funds, but it fluctuates a lot more than the overall stock market. During the past three years, for example, the fund was 67% more volatile than the S&P 500.

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Action to Take --> For investors interested in the huge profit potential of Internet stocks, the PowerShares Nasdaq Internet ETF is a top choice. Through broad industry exposure, it avoids the pitfalls of trying to identify the best individual players -- a difficult task considering all the hype, unpredictability and nosebleed valuations associated with internet stocks.

Because of its small asset base and tiny premium, I suspect investors haven't yet fully embraced PNQI. So now is a good time to buy, before the premium rises. What's more, Internet stocks haven't fully recovered from their drubbing earlier this year and may still offer attractive near-term profits. However, I like PNQI more for its long-term upside as Internet use continues to rise globally, especially in developing countries where much of the population isn't yet online.

My colleague Andy Obermueller is also intrigued by the Internet's seemingly limitless potential. In his latest report, Andy identifies five other "game-changing" trends with the potential to revolutionize the way we live our lives -- and make early investors a killing. To learn more about these emerging trends -- and the companies behind them - follow this link.

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