Overstock.com Still Looks Like a Bargain

 | Jun 07, 2013 | 3:30 PM EDT
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Overstock.com (OSTK) has been one of the market's brightest stocks of 2013, but is it still cheap and is it a better buy than its competitors?

In the last year alone, shares of Overstock.com have rallied almost 300%, as margins and revenue have increased and as the company has raised its outlook. Overstock.com operates a very similar business model to its competitors eBay (EBAY) and Amazon (AMZN). While each company has its niche, it is also fair to compare them. Let's look at a few key metrics to determine whether Overstock.com would be a good addition to your portfolio.

The measures of valuation above are what I refer to as "homepage metrics," because these are the first metrics that retail investors see, and each is universally used in the process of valuing a company. Retail and institutional investors give serious weight to these metrics when making investment decisions.

Clearly, Overstock.com is a much smaller company than either eBay or Amazon. Overstock is at a different stage in its business cycle, yet it hasn't seen the explosive growth that eBay or Amazon produced when they were the size of Overstock. Thus, many people fear that its upside is limited, but when we compare Overstock with its larger competitors, we can see that Overstock is quite attractive.

First, it is slightly more expensive than eBay on the basis of earnings. However, for Internet-based companies, growth is often preferred over profit. To me, when assessing upside and value in Internet-based companies, it is most important to judge a company's valuation relative to sales, growth and margin upside.

What I really like about Overstock.com is that it's trading at just 0.55x sales, despite a near 300% one-year gain. The company has comparable growth to its larger competitors, and apparently it has significant room to improve its margins, unlike eBay.

In my opinion, eBay is without question the worst investment of the three. The company's growth is slowing radically, and since it has operating margins of 21.06%, there isn't much room for vast improvement. Much like Apple (AAPL), eBay is reaching a point in its business cycle where it may have to sacrifice margins if it wishes to grow. But since eBay trades at 4.69x sales, much of its valuation is tied to its operating efficiency.

Since Amazon and Overstock have operating margins under 2%, there is significant room for upside. Both companies are investing in growth, but they will have the luxury of eventually scaling back costs to improve operating margins. Amazon in particular is becoming an advertising force -- it expects $835 million in ad revenue this year, a $200 million surplus year over year. Since advertising has high margins, this could become a source of margin growth for Amazon.

For both Amazon and Overstock, I definitely believe that operating margins of 6% are possible, and that is what Wal-Mart (WMT) produces. Of course, this would be several years down the road, but both Amazon and Overstock.com spend the majority of their gross profit on selling, general and administrative costs, reinvesting money back into the business. Overstock is currently trading at just 3x its last 12 months' gross profit, and Amazon trades at 8x gross profit. To me, it's this potential upside that makes Overstock attractive. And on the basis of sales, it is without question the best value in the space.

The original argument was whether or not Overstock.com is still presenting upside. Compared with its peers, it is obviously cheap and still has significant room to improve. Therefore, as long as improvements in both revenue and margins continue, I believe Overstock.com will be the best-performing stock of the three for many years to come.



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