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October 21, 2010

Through The Noise eBay Is Still On Track

eBay, Inc. reported yesterday and the market seems to have like what it heard. The stock is up over 8% day-over-day to $27. Paypal, the company’s online payment platform, continues to shine as its revenues grew 40% over the quarter-to-quarter. However the picture was not all rosey. The company’s main business, dubbed Marketplace, grew only 3%. If CEO John Donahue wants to meet his three year goals of turning this aspect of the business around, he has some work ahead of him.

With that, one quarter should not make or break a company. At least, we’d hope. So I thought I would check to see how eBay is performing compared to where I thought they’d be at this point. You may recall a post a few years back where I did a discounted cash flow analysis on eBay. At the time, the company was trading at about $30. I then said based on my projections of free cash flow, the company was actually worth $60. According to that analysis (here), eBay should have been producing free cash flow somewhere in the $2.2 to $2.7 billion range. Some three and half years later eBay reports free cash flow of $1.9 billion. This includes a one-time tax payment of $207.4 million related to a legal entity restructuring. If we were to add back the $207 million eBay would have a FCF of $2.2 billion.

So it seems my original analysis which had eBay at valued at approximately $60 in 2006 was a pretty decent estimation. The beauty is, eBay is cheaper than it was then, even after an 8% run up, at $27. If Paypal keeps chugging along and Donahue can get Marketplace on track, the analysis I did back in 2006 should remain valid.

Disclosure: I and the clients of Brick Financial Management, LLC owned shares in the companies or funds mentioned in this post at the time of this writing. But positions may change at any time.

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July 20, 2009

Why I Don't Trade (Often)

This past January, about the time of Obama's inauguration, Warren Buffett gave an interview to PBS corresspondent, Susie Gharib. In the interview Buffett was asked to give his greatest and most important business lesson. He responded:

The most important investment lesson is to look at a stock as a piece of business not just some thing that jiggles up and down or that people recommend or people talk about earnings being up next quarter, something like that, but to look at it as a business and evaluate it as a business. If you don't know enough to evaluate it as a business you don't know enough to buy it. And if you do know enough to evaluate it as a business and its selling cheap, you buy.

When thinking of stocks as more than just pieces of paper, but actual representations of underlying businesses, the investor is led to a more sensible approach. If as an investor you were considering buying a business that you would own, operate and would provide the majority of your income, it is likely you would not contemplate selling that business within seconds of purchasing it. Just as you would not think of buying a home in the morning and selling it in the evening, if your intent was to live in it.

A great example is Google (GOOG). Google is the dominant player in the search engine world commanding more than 64% of internet searches and is rapidly becoming a threat to longtime tech behemoth, Microsoft (MSFT). Google also produces and obnoxious amount of free cash flow and seems to grow that cash at will (see chart).

Google's Free Cash Flow

With market dominating performance and consistent operating results, it is safe to assume Google's business value is stable and steadily growing. But if you were to look at the stock price, you'd never know it. In the past 52 weeks, Google's shares have gone from a high of $510 to a low of $247 and now sit at around $430. Do these wild fluctuations make any sense given Google's performance? Nope. But for those of us who are more concerned with the underlying business, we can just sit still and only move when to buy when the market greatly undervalues our business and sell when they overvalue them. This is why I don't trade very often and prefer the "lazy" approach to investing.

Disclosure: I and the clients of Brick Financial Management, LLC owned shares of Google at the time of this writing but positions may change at any time.

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May 18, 2006

Ebay: A dollar for 50¢?

EbayEbay’s current price has sparked me to consider a few things. First, am I “correct” on eBay? My general thesis on the company is that it is an undervalued market leader. The other question that comes to mind stems from the first one. If I am correct, why am I correct and the market wrong? It certainly isn’t that I possess some supernatural intellect or clairvoyance. (Trust me.) All I know is that I have looked at eBay’s operating performance numbers and to me the numbers just don’t spell 30 bucks per share.

What numbers am I referring to? Well primarily I’m referring to eBay’s free-cash-flow (FCF) figures. Recognizing that there is a plethora of ways to arrive at FCF and keeping in mind that exact numbers give a false sense of preciseness, I estimate that eBay produces about $1.4 billion in FCF. And over the last few years the company has been able to grow those figures at extraordinary rates – by at least 40% and by as much as 90%.

Using the discounted cash flow (DCF) method, I arrived at an estimated intrinsic value for eBay of about $60 per share. Of course, this method of valuation is very sensitive to the assumptions made. To come up with my estimate, I assumed a discount rate of 9% which is my optimistic view of what the market itself will return over the next decade or so. I also assumed that eBay’s FCF growth rate would substantially decrease over the next 10 years - falling from 25% in the early years to 12.5% in the later years. And then I assumed a terminal growth rate of 3%, about the historic rate of inflation. With those factors, all of which I think are reasonable, I came up with an estimated value of $60. So the market must be missing something…possibly. Click chart for larger view.



But what if I’m wrong and the market is correct? Perhaps I’m missing something. One way or another the market is saying that eBay will not be able to perform in the future as it has in the past. The market seems to be saying that some external (or internal) force will do one or a combination of several things. The forces will depress eBay’s margins or retard its sales growth or cause it to have to substantially increase its capital expenditures.

I think one thing the market is saying is that it doesn’t like eBay’s purchase of Skype for $2.6 billion. I agree with the market here. I like the company, I just don’t like the price eBay paid for it. That said I doubt that any failure in Skype will be enough to sink eBay. The market may also be saying that the Google-monster will surely do eBay in. I doubt that pressure from competitors like Google or Yahoo will be significant enough to substantially hurt the company. Not in the long run anyway. And certainly not enough to justify the $30 price tag eBay now sports.

In my own analysis, I assume that eBay’s FCF growth falls off a proverbial cliff and I still came up with a value that is at least twice the current market price. In other words, I think eBay represents the dollar being sold by Mr. Market for 50¢. Yet exploring the reasons Mr. Market is selling eBay so cheaply are worth some thought.

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April 26, 2006

Wal-mart vs. Target (Rule #1)

Last week I wrote that I would be running a few companies through Phil Town’s criteria for Rule #1 investing. To recap,

Town suggests that the way to adhere to Buffett’s first rule is to look at five different things about a company. They are: 
  • return on invested capital (ROIC),
  • revenue (sales) growth,
  • earnings per share (EPS) growth,
  • equity (or book value) growth, and
  • free-cash-flow (FCF) growth.
He says that we should be looking for companies with at least 10 years of history, and except no less than 10% per year in each of the growth figures. We should also look for companies with an ROIC of at least 10%.

I decided that the first two companies I’d look at would be Wal-Mart (WMT) and Target (TGT). These are two of the major players in the retail industry.

Unless you’re Paris Hilton, you’ve heard of Wal-Mart. Wal-Mart interests me because so much of the value investing community has become enamored with the company. Wal-Mart concentrates its products for very price sensitive consumers, usually in rural and “non-urban” areas. Although recently, the company has made great efforts to expand its operations into more “city-fied” areas. Target on the other hand, caters to a more urban, fashion conscious consumer. Usually, their consumers are a little higher up on the disposable income scale and are less price sensitive.

Full disclosure: Although I (and the clients of Brick Financial) do not own either company, both are on my watch list. My current outfit however consists of socks, underwear and a belt from Wal-Mart and jeans, a shirt and a watch from Target.

Each seeing the other as a threat, they have recently (in the last few years) found themselves competing more and more with one another. Selling products and services designed to poach the others customer base. Will either be successful? Of course, only time will tell.

Here’s how the stocks of the two companies have performed over the last 5 years. [Click on the image for a larger view.]


 

As we can see, over the last 5 years, Target has returned over 40% while Wal-Mart has lost market value. To peer into the reasons why this happened, we need to look at how each company has performed operationally over the last few years. Here is where Town’s Rule #1 criteria may help us. For each company, we collected the figures using MSN Money and listed them in the table below. [For most of the multi-year figures, we used a geometric growth rather than an average growth.]

You should note that if I were doing this analysis for actual investment, I would use each company’s actual financial statements. But in order to keep it simple, and to try and follow Town’s book as closely as possible, I just used MSN.

You should take note of two more things. For the free-cash-flow (FCF) figures, I used the more traditional calculation of cash from operations minus capital expenditures. MSN also subtracts out dividends. Additionally, I included Warren Buffett’s calculation of “owner earnings” which is net income plus depreciation and amortization minus capital expenditures. This is his definition of free-cash-flow. These figures are from the latest annual financials statements. [Click on the image for a larger view.]

 

After looking at these figures, and grading them against Town’s criteria, I would say that each company probably gets a passing grade on the level of a B- or C+.

Wal-Mart averages over 10% in growth for most of the figures except for FCF and owner earnings. These two figures have declined over the last few years. And nearly all of the growth figures have trended downward.

On the plus side, Target’s EPS an equity growth are much higher than Wal-Mart’s and far exceeds Town’s minimums. But its sales growth and ROIC haven’t consistently beaten Town’s 10% floor. Whereas Wal-Mart’s FCF has been declining ever so slightly, Target’s FCF took an astronomical leap in the last year. But I wouldn’t get too excited about that since the previous year’s FCF was so low. (Gotta watch those base year figures.) For the 5 year period, Target only had one year where the company had a positive FCF or owner earnings figure. But the trend in FCF and owner earnings is good, as Target is growing its cash at a faster rate than its capital expenditures are increasing.

From the operational figures, neither Wal-Mart nor Target distinguishes itself from the other (using Rule #1) criteria. Thus, I don’t think these figures give us any insight into why Target’s stock may have performed better over the last 5 years. My guess, without the benefit of looking back, would be that Wal-Mart’s stock was richly valued 5 years ago relative to Target. Or it could be that investors think that Target has a brighter future. Or perhaps, everyone is crazy.

What I also want to know is, at this point, which would be the better investment. I want to know the value investors I admires are raving about Wal-Mart and Target...not so much. This is where the ever important valuation of the companies comes in.

I will explore these points in a future post.

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About Brick Financial Management, LLC

Blogged by Brick Financial

51 JFK Pkwy, 1st Fl. West
Short Hills, NJ 07078
973-486-9860
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Brick Financial Management, LLC is a Registered Investment Advisor specializing in providing investment management services to individuals, families, organizations and institutions. We implement highly focused stock, bond, and balanced portfolios using an investment approach commonly referred to as value investing. Disclosure

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