Shares of eBay (NASDAQ:EBAY) have been performing relatively poorly when compared with the rest of the market. The stock is down 11 percent for the year, which means that it has underperformed the S&P 500 by about 15 percent. Currently the stock sits near a fifty-two-week low, and it appears as if there is little to no technical support until it reaches the low $40’s (it currently trades at $49/share).
Nevertheless the stock is starting to look attractive on a valuation basis. Despite the fact that the stock is trending downward earnings and sales are trending higher. While a $3 billion tax-related write-down hit the reported earnings number for the first quarter the company’s operating income grew by 12 percent. Meanwhile sales grew at 13.7 percent. While this reflects a reduction in the company’s aggregate operating margin if we look under the hood we see a different story. The apparent margin compression is a result of the fact that the company’s fastest growing business is PayPal, which is a lower margin business than the eBay Marketplace business. As Paypal continues to grow the discrepancy between sales growth and operating earnings growth will subside.
Despite this growth the company trades with a very modest forward price to earnings multiple of about 16.4, and this shrinks as the company is expected to continue to grow into 2015 so that the price to earnings multiple on 2015 earnings is just 14.4. In a market where growth is difficult to come by one would think that investors would be willing to pay a premium for eBay shares. It is also surprising that eBay stock is so inexpensive considering the long-term trend in the growth of e-commerce that is in large part driving eBay’s sales growth.
There are two things holding the stock back.
The first is that investment dollars that go into e-commerce usually find their way into Amazon. Investors are convinced that Amazon’s revenue growth and its relentless reinvestment of its cash-flow will once day generate incredible earnings that will more than justify paying $150 billion for a company that has earned about $2 billion over the past four years (by comparison eBay earned $2.8 billion just last year and it is valued at $62 billion). Therefore eBay, as a beta to Amazon’s alpha, needs to prove itself through profit growth and stock repurchases. In other words eBay will be dragged higher as earnings rise because the speculative momentum players aren’t interested.
The second is that investors are concerned about competition from Amazon (NASDAQ:AMZN). Amazon has recently announced initiatives that are clearly aimed specifically at eBay. These include selling collectibles and, more importantly, offering online money transfers that are similar to Paypal’s.
But Amazon’s attempt to compete with Paypal appears to be a long-shot, as Paypal is well established and has unrivaled market standing. Even if Amazon were to take some market share, and it will almost certainly take at least a little, the market is growing quickly enough to handle a new competitor, and Paypal should be relatively unscathed.
In other words there isn’t much to be concerned about and an investment in eBay seems to be relatively safe, particularly given the aforementioned valuation figures I mentioned above.
Ultimately as eBay shares have declined they have become more appealing to value investors. While there are concerns about competition and a lack of speculative money driving the stock higher the simple fact of the matter is that eBay generates a lot of free cash-flow and it is growing this free cash-flow generation at a significant rate, thanks to its rapidly growing Paypal business. With the stock trading down in the face of this observation it looks as if value investors should start to consider taking a position.
Disclosure: Ben Kramer-Miller has no position in eBay or in Amazon.