Novice Investing - Bidding For eBay

Date: Friday 05th 2008f September 2008 05:48:27 PM

Bidding For eBay - 11/17/2005

By: Novice Investing Staff

Today, we will look at another growth stock candidate, eBay Inc. (EBAY). The largest internet marketplace recently fetch a market capitalization of $ 59.2 Billion and it has been profitable since the day it went public. Amazon.com and Yahoo! Inc. (YHOO) tried to set up their own marketplaces without much success.

With a wide moat for its business, will eBay continue to grow? How much do investors expect eBay to grow in the coming years? We shall see from the following exercise.

Let's look at eBay's latest balance sheet. As of Sep 30th 2005, eBay has a cash & cash equivalents balance of $ 3.1 Billion versus $ 0 of long term debt. This translates into $ 2.22 per share of positive net cash.

eBay is currently traded at $ 42.54. At current stock price, the real price of eBay's business is therefore ($42.54 - $ 2.22 ) = $ 40.32 per share. Earning per share for eBay is expected to hit $ 0.84 for the year ending on December of 2005. Again, we will estimate eBay's growth rate from an article Calculating Fair Value With Growth. Assumptions that we use will be similar. We assume that eBay can grow its business at a certain rate and earning will slow down to 0% growth five years from now.

Currently, eBay is trading at ($40.32/$0.84) = 48 trailing P/E ratio where the 'P' here is the real price of eBay's business and not the stock price. With 0% growth and 4.5% risk free interest rate, a stock is fairly valued at a P/E of 13.4. If eBay is fairly valued now, then investors must assume that eBay will hit earning of $ 3.01( $40.32 divided by 13.4) within five years. Using an interest rate of 4.5%, present value of $ 3.01 will grow to $ 3.75 in five years. In other words, money that is worth $ 3.01 now will be worth $ 3.75 in five years. Calculating earning growth from the base earning of $ 0.84 currently to $ 3.75 within five years, gives us an annual EPS growth rate of 34.9 %

The price looks steep? It looks like it. If eBay can grow 34.9% for the next five years then it is fairly valued now. There are a lot of potential in the internet space. Perhaps, eBay can grow much faster than that. Perhaps, the acquisition of Skype gives a vast untapped market for eBay. Whatever it is, if you think that the company can grow its earning faster than 34.9% annually, then eBay has not reached its fair value.

Let's do another exercise. If you think eBay can only grow its earning for 20% annual growth, how much should it be fairly valued? Using a base earning of $ 0.84, at the end of year five, earning will hit $ 2.09 before leveling of. That $ 2.09 is worth $ 1.68 in present value. If 10 year bond stays at 4.5% yield, applying a P/E of 13.4 gives the fair value of eBay's business at $ 22.5. Adding $ 2.22 of positive net cash to it, eBay's stock price is fairly valued at $ 24.72 if it can only grow earning by 20% for five years and then hit a ceiling.

You be the judge. We haven't researched eBay that much and therefore, we have no idea how much growth can eBay most likely achieves. It is just a guessing game at this point for us. If you have followed eBay closely, you are welcomed to post in our forum and give a ballpark number for eBay's estimated growth rate.

END

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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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