Novice Investing - Auctioning your eBay stock

Date: Monday 01st 2008f December 2008 04:44:50 PM

Auctioning your eBay stock - 08/01/2006

By: Novice Investing Staff

Late last year, we did a simple fair value exercise on eBay Inc. (EBAY). At the time, we feel that the stock is pricey, trading at around $ 40.00. With a recent price of $ 24.07, is it worth to give eBay a second look? Back on November 2005, a simple calculation shows that eBay was fairly valued if it can grow earnings 34.9% for the next five years. Further, if we assumed that eBay can only grow earning 20% annually for the next five years, the stock price would be fairly valued at $ 24.72, which is what it is trading currently. Note that by buying a company that is trading close to fair value, you might not profit from your investment. To pick a profitable investment, you need the stock to be trading far lower than fair value.

So, let's make a review on eBay and take note what has changed since our last assessment. As of March 31st 2006, eBay has $ 3.53 Billion of cash equivalents and long term investment while incurring $ 0 long term debt. This is equal to $ 2.50 of positive net cash. Annual EPS estimate is now predicted to be $ 1.01, up 20.2% from last year. That is good. Profit for eBay is growing. However, it also shows that eBay does not grow as fast that the $ 40.00 price indicated back on November 2005.

That was history. How about going forward? Yahoo! Finance showed that analysts expect an EPS of $ 1.27 in 2007, up 25.7% from 2006. Again, this shows that eBay can't grow earnings at 34.9% clip. If you scroll down to the analysts' prediction for eBay, you will see that they expect eBay to grow earnings at 21.2% clip for the next five years. Thus, it is official. eBay at $ 40 was way overvalued. Meanwhile doing similar exercises as last year on eBay, in year 5, EPS will come in at $ 2.62 per share. In today's money, this is equivalent with $ 2.10 per share. Currently, 10 year bond is yielding 4.99% up from 4.50% late last year. Assuming the same risk tolerance, we would need eBay to give us a yield of 8%. This translates into a fair P/E value of 12.5. For eBay, with present value earning of $ 2.10, fair business value for eBay is $ 26.25. For fair stock value, we need to add positive net cash into the business, and we get ($ 26.25 + $ 2.50) = $ 28.75

At current price of $ 24.07, eBay is trading slightly less than its fair value ($ 28.75). While it is a lot cheaper than on November 2005, this fair value assumes a 20% growth for the next five years. Should eBay fails to grow at that rate, fair value of its common stock would be revised down. We will not say eBay stock is overvalued at this point. However, it is not as cheap as you think, despite having drop 50% from its 52 week high. You can find better bargains by spotting companies trading below fair value even if it has a 0% earning growth.

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding eBay Inc. (EBAY) or any other securities.

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