"We see a more balanced risk-reward following strong performance," Morgan Stanley analysts, led by Scott Devitt, wrote in a note to investors Monday.
The Internet stocks they cover, including Amazon, Facebook and Google, are up 57% so far this year on average, while the benchmark Nasdaq Composite Index has gained about 28%.
"Outperformance has been driven by multiple expansion rather than positive estimate revisions," Devitt and his colleagues added. "Consequently, we believe current valuations could be full despite strong secular trends."
The analysts cut their industry view to "in-line" from "attractive." That means they expect Internet stocks to return about the same as the broader market over the next 12 to 18 months, rather than beat it.
They also took Google off Morgan Stanley's Best Idea list, arguing that most of the catalysts for that stock's gains have already played out.
Investors have been betting that companies in the sector will have a much bigger market to tap as tech-savvy, younger generations mature and enter their heavy-spending years when they buy cars, houses and many other expensive items. The hope is that these consumers will do most of their searching and spending over the web, boosting revenue and profits of the leading Internet companies.
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Devitt and his fellow analysts call this the "total addressable market," or TAM, investment strategy.
"There may not be enough TAM for all of our companies to achieve long-term estimates," they wrote. "We could see a return to a more valuation-sensitive investment process as the fallacy of a broadening TAM approach to investing becomes more evident to the market" possibly in 2014.
Morgan Stanley's estimates ! for 2014 earnings, before interest, tax, depreciation and amortization, have increased 1% to 2% so far this year, while the value of Internet companies has jumped 57%, the analysts noted.
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