eBay Stock: Time to Look at Valuation

eBay stock has remained essentially flat over the past six months. Meanwhile, the S&P 500 is up about 15%. After the stock's underperformance, now is a great time to re-evaluate shares to see whether the decline provides investors with a notable entry point.

eBay is here to stay
It's no secret that eBay has one of the most capital-efficient business models in e-commerce. The company has an operating margin of 20.9%. For comparison, Wal-Mart and Amazon.com's trailing-12-month operating margins are 5.9% and 1%, respectively. With such an efficient business model, the company is a cash cow. eBay manages to convert about $0.20 of every dollar of revenue into free cash flow. As a result, the company boasts a massive $11.5 billion cash hoard.

Furthermore, eBay's marketplaces segment and PayPal both benefit from powerful network effects.


The eBay marketplace becomes more useful with every additional user, strengthening its value proposition for both buyers and sellers. And rest assured, its marketplace is still growing. In the company's first quarter, enabled commerce volume was up 19% from the year-ago quarter. Net active accounts were up 16% in the same period.

In conjunction, PayPal's network effect is derived from mass adoption of PayPal for eBay payment. Plus, PayPal has significant advantages over many of its payment peers, particularly lower fraud rates. 

The bottom line? eBay isn't going anywhere. This means it's safe to make a conservative estimate of future cash flows based on its consistent, historical trends. Rest assured that eBay is a prime candidate for a discounted cash-flow valuation.

By the numbers
A discounted cash-flow valuation should never be used as the sole basis of any investment decision. But it is a great tool for determining whether or not a stock is at least in the ballpark of a buying range.

Though eBay's two largest business segments, marketplaces and PayPal, have very different average compound-growth rates over the past three years (marketplaces, 12%; PayPal, 25%), PayPal accounts for a smaller portion of eBay's total revenue. So it's safe to use the company's overall historical growth trends in free cash flow as a guide for deriving our future ballpark figure.

With a three-year average compound growth rate, eBay's FCF of 13%, and little sign of a slowdown, a conservative estimate of eBay stock valuation for the next 10 years would look something like this:

Year

Growth Rate

1

13%

2

12%

3

11%

4

10.1%

5

9.3%

6

8.6%

7

7.9%

8

7.3%

9

6.7%

10

6.1%

Using a 10% discount rate, growth expectations like this would yield a fair value of eBay's shares at about $54, giving eBay stock around a 5% margin of safety at today's prices.

Keep in mind that my projection is fairly conservative. A 5% margin of safety may seem small, but we're talking about one of the Internet's most efficient business models. If not a buy, eBay stock is definitely worth adding to your watch list and researching further.

To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

The article eBay Stock: Time to Look at Valuation originally appeared on Fool.com.

Fool contributor Daniel Sparks has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Amazon.com and eBay. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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