Sunday, January 02, 2005

Weekly Investment Roundtable - EBAY (NASD: EBAY)

This week's Investment Roundtable will be discussing eBay. We have brought together many great writers with many great opinions. I know these roundtables can be long to read, but every word is important. As always, these articles are for educational purposes only. This roundtable should only be a part of your own investment research process.

This might be the first time that some of you have visited my investment site. I hope you take a look at some of my other articles after you have read the roundtable.

This "blog" is my way of helping individual investors learn to invest with the long-term in mind. To make it fun to learn along the way, the individuals who visit my site regularly and I are taking on the Oracle of Omaha. Mr. Buffett is currently the most famous investor to come out of my home town, but I want to change that. So, please come back often to see how my progress is coming along. I have put together a real portfolio with real money to make things more interesting.

So, if long-term investing is something you want to learn more about, come back often and I'm sure you will learn something. Thanks for stopping by and enjoy this week's roundtable discussion of eBay.

Best Regards,

The Soothsayer of Omaha

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Dr. Ron Sen for the Investment Roundtable
Ron's Stock 'n Stuffer World

Disclosure: my son is an EBAY employee. To my knowledge, I have no inside information that could affect my ability to buy, sell, or hold EBAY stock.

EBAY has largely become an Internet icon. The company, based in San Jose, California, apparently hopes to become a middleman in as many global transactions as possible. They receive a fee for providing the framework for online sales of a variety of merchandise.

As always, my trading analysis comes from a graphical analysis.

Market conditions: the NASDAQ is above the 200-day average (extended at over 10 percent above at the time of this writing). HHH, the Internet Holders Trust is over 18 percent above its 200 day average. EBAY specifically is 24 percent greater than its 200 day moving average.

Daily

Price: EBAY has just made a closing high on Wednesday December 29, 2004, at 117.57. Although EBAY, the Internet sector, and the NASDAQ are all extended, that is not necessarily a reason to sell or to sell short a stock. As we all witnessed during Mania One and again are witnessing during Mania Two, stock market moves can proceed much farther than we might imagine. Stock market manias are well chronicled in Edward Chancellor's Devil Take the Hindmost.

Weekly

Pattern: EBAY hasn't shown anything to suggest a reversal pattern (e.g. double top, head and shoulders, exhaustion gap/island gap). Sometimes on a daily chart (particularly noticeable on Equivolume charts) a stock will suddenly top with heavy volume. Generally, as I have noted before, short positions are better considered from after a period of stagnation, sometimes after a transition pattern or first thrust downward as described by Dave Landry. Note how on the weekly chart that volume has declined.

Trend: EBAY has remained in a very lengthy uptrend over the past two years, emerging from a base during most of 2002.

Time: EBAY has made relative lows at about nine month intervals, of which the next would be due about the beginning of the second quarter 2005 (presumably meaning a relative top would come prior to that.

Note that using 10 period ADX on the weekly chart, that the stock is trending with extreme strength (trending stocks are usually > 25, with strong trends over 30) meaning that oscillators have less application here.

Structural factors: EBAY has an extensive Trust and Safety division devoted to attempt to detect and prevent fraud. Online fraud, identity theft, and computing security issues are the greatest barriers to entry in the online sales industry. EBAY's massive security program gives it a substantial advantage over competitors seeking entry into the online auction business. EBAY presumably seeks to make their PayPal division the principal transaction processing mode for worldwide Internet commerce.

Potential issues: EBAY has a very large number of options outstanding. Heretofore, generally accepted accounting principles have not required companies to treat these options as compensation, i.e. as an expense versus earnings. As of June 15th, 2005, the current plan of the FASB is to require companies to treat options as an expense. I do not know the impact of EBAY's options on earnings, but presume that it will be material to their reporting.

EBAY is one of the great growth stories available. EBAY investors have bought growth, and prospered with the growth. One has to wonder whether the growth occurs at reasonable prices.

According to YHOO, EBAY's free cashflow is about 865 million dollars, and the book value is about 9.2 dollars per share. Diluted Earnings per share are reported at 1.056 dollars, but there’s the rub. What impact do options have on EBAY and what are its core earnings? Core earnings are earnings teased out after the effects of one time changes, options, and pensions are discarded. According to BusinessWeek Online: S&P Core Earnings for the trailing twelve months to October 2003, EBAY has core earnings of 31 cents versus 61 cents reported. BW Online February 24, 2004 eBay: Where the Action Is Online estimated core earnings for EBAY 2004 of 67 cents. They estimated 53 percent cash flow growth to 2006.

If we estimate 60 percent core earnings growth for the next three years, then EBAY would have core earnings of $2.74 for 2007 and a multiple of 50 would make the stock price $135 at that point.

If we estimate 50 percent core earnings growth for the next three years, then EBAY would have core earnings of $2.26. A multiple of 50 would price the stock at $113 in 2007.

I remember seeing CSCO at 70 dollars, and a five-year growth analysis carried out (estimating 25 percent quarter over previous year quarter) with a multiple assigned (as a mature company) of forty. The stock price would have been about 65 dollars a share. EBAY is a great company and technically strong, but I have no way of calculating the risk relative to the growth assumptions, so I'll pass.

If I were a single stock millionaire on EBAY, I'd definitely sell January 2006 140 calls at around 7.60 and buy January 2006 95 puts at 5.50. I should be so lucky.

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Tom Ott for the Investment Roundtable
Sixth World Management and Commentary

Happy New Year fellow Roundtable readers! It's 2005 and I have a feeling that this year the markets will be in for a wild ride. As you know, we have so many macro-economic "problems" out there that is sure to give some us sleepless nights. Enough of this gloom and doom for now let's turn our attention to today's Roundtable stock EBay (EBAY). What can I say; I love what this company has done for e-commerce. Take the simple concept of auctioning, put it on the web, and you end up revolutionizing the way e-commerce. Under CEO Meg Whitman's leadership, EBay has grown to be the 800lb gorilla of online auctioneers and no one can even compare. Above all EBay was profitable from day one (well not exactly on day one but you catch my drift). Perhaps that's one reason that EBay has stood the test of time when so many others have imploded during the Dot Com bust.

The question that all of you are probably asking right now is, "should I buy EBay?" The answer is NO, not right now but soon. Our first look is at the weekly chart for the period between March 2003 and December 2004. What you'll surely see is that EBay has rallied long and hard since October 2003. The smart money piled in then and EBay took off like a rocket. It's in a nice upward trend and it clearly looks like an Elliot Impulse wave. The only thing that we don't know quite yet is where Wave V will end up but there are clues here that lead me to believe EBay's run is almost over.

Weekly

It's clear to see that volume is drying up over the course of the months since October 2003, STO is oversold, MACD & OBV seems to be peaking and the big money inflow seems to be ebbing. Although the MMA's are flashing bullish signs, the Bollinger Bands are narrowing signaling a decrease in volatility and a potential violent move in either direction. I believe that EBay is running out of steam. I'm placing a SELL rating on this stock if you're long. It's time to take profits. Why? The compelling reason why I say sell is that a WAVE V wants to form at the top of the trend channel. So folks, it looks like to me that EBay's run is over.

Let's zoom into a daily chart.

Daily

I think EBay has hit its resistance level at about $118.35. Why do I call it resistance, just look at all those spinning tops and doji’s at that level on Dec 3rd and 6th. Then see them form again on Dec 15th and 30th? Now, taking the possibility that WAVE V is forming, I feel that EBay is going to correct. How far could she correct? A good guess would be a retracement of 38.2% of the full impulse wave or (118.35 - 25.11) * 0.382 = $35.61. Wow that’s a big retracement but it could happen. I've seen so many violent price swings in this market. A retracement of that magnitude would put EBay at a price target of $82.73. Now that would make a real attractive buying price for this author!

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Levi Bauer for the Investment Roundtable
The Soothsayer of Omaha (No Link...You are already here)

As with all of the stocks the Investment Roundtable has analyzed so far, eBay is not a value stock. eBay is a growth story and will continue to be for a few more years if not many more years. I don't even have to look at the criteria to determine this, but I will just so you know what sort of metrics Benjamin Graham was fond of.

P/E 136 = No, the Graham criteria requires a P/E below 20
Price/Book 12.82 = No, the Graham criteria requires a P/B below 1.5
Current Ratio 3 = Yes, the Current Ratio should be above 2
Revenue Growth 116.76% (Past 5-Yr Avg.) = Yes, Revenue Growth should be above 15%
Intrinsic Value $92.50 (S&P Fair Value) = No
Dividend Yield 0% = No

eBay difinitely has its debt under control and is still currently in the growth stage as witnessed by revenue growth in the triple digits. The only reason eBay is not a value stock is because of it's current share price, which is a symptom of growth companies with growth stories.

Guru analysis over at nasdaq.com gives eBay a grade of 57%. eBay passed 57% of the value criteria that nasdaq.com believes Benjamin Graham would have used.

The company is in good shape with regards to its fundamentals and key business areas. The value of the company's shares takes eBay away from the value investor.

eBay has turned itself into a powerhouse. The company went from selling Grandma's old Scandanavian dolls that you just found in your garage to selling overstock items from name brand companies. You can now honestly find anything you could ever think of on this one website. No wonder they are swimming in cash.

eBay currently has $1.72 billion in cash with free cash flow at $865 million, which is a 70% increase over the prior year. Having a lot of cash sitting around helps out, but so do 80%-plus gross profit margins.

eBay is not a value play. If you are looking for value stocks, stay away from this one. For those of you who are still interested in eBay as an investment, here are my two cents about the technical picture. As always I start out with the long-term picture and whittle my way down.

Weekly

Looking at the weekly chart I see nothing but trend strength. As you can see, eBay is in an uptrending channel that began in 2003. eBay's share price is currently at the top of this channel and will most likely come down to test the bottom once again. The 50-Week Moving Average will also provide support at the bottom of the channel.

The upward trend is not only pretty strong, it is also wide. A more risk adverse trader/investor could make 15%-plus by purchasing at the bottom of the channel and selling at the top (30%-plus if you would sell short as well).

It's been said before that trends are made to be broken. This is true. Every trend is broken at some point in time. You have to be aware of the signs of the impending top. Currently I do not see any significant signs of a topping area in eBay's long-term outlook. One clue might be the decreasing volume, but that hasn't been a very good indicator with this particular stock.

When the uptrending channel is broken, eBay will still be in a long-term uptrend and will continue to be until the uptrend line that began in 2001 is broken. This area also finds support from the 200-Weekly Moving Average. The long-term technical picture looks quite strong for eBay. You always have to make sure that you are buying at support (bottoms) and not at resistance (tops), though.

Now that we believe eBay is in a strong long-term uptrend. Let's look at what the shorter term chart is telling us.

Daily1

According to the daily chart eBay is finding support along the uptrend that began in August of this year. This trend line would have to be broken before you would even consider selling. If you are considering jumping on the eBay stock train, I wouldn't look to purchase shares until they come back down to the bottom of the trading range. The bottom of the channel is currently at $90.

You should have noticed that eBay's share price is currently outside of my drawn channel. The upper part of the channel is called the secondary trend line. The bottom part of the channel is the primary trend line. You will notice as you become a more aware trader/investor that secondary trend lines do not hold very often. That is why I would wait until eBay's share price comes back down to the bottom of the range. My experience has shown me that the secondary trend line is not going to hold.

Helping out my theory that the secondary trend line is not going to hold is the bearish divergence occurring currently with regards to the RSI and share price. You will also notice the lack of volume during this last upward push.

There is a wild card with respect to the uptrend line that is moving through the trend channel. You could definitely see some support at this line in the future. Make sure you watch for it.

In summary, I would not purchase the stock as of right now. I would look for lower levels of support to add positions in eBay to my portfolio.

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Bill Cara for the Investment Roundtable
www.billcara.com

There is a concept in the stock valuation biz called "perfect pricing". To some of us, that's a black flag; the race is over. To others, however, it merely means that conventional investment analysis based on Graham and Dodd can be dismissed on account of overriding Quality considerations.

I think we can agree that EBAY is perfectly priced; however, if you are seeking Growth At a Reasonable Price (GARP) or good Value, then you are likely not interested in EBAY (the stock). Perfect pricing suggests that in order to stay invested the investor is willing to take all the risk. For buy-and-hold investors, that's probably not a good idea.

Now you know risk can be an open-ended subject. There are risks related to the stock market prices, credit/solvency, independent business valuation, and management performance, among others. In fact, if you are a classic worrier, the list of risks becomes endless.

But the skinny on risk is that the more of it, the shorter ought to be your hold period.

Since I like EBAY's biz model, and I know EBAY has millions of happy customers, I am prepared to trade the stock. However, in my book I cannot find it in me to more than day trade a stock that has a price-to-earnings multiple north of say four times the S&P multiple.

Since EBAY trades at something like a 111 PE, my time horizon for long trades is measured in minutes, possibly hours. Even with short trades, my window would be hours to days, but never weeks.

Simply put, the risk of "news" is too great for me to accept. A lot of market news, you know (or ought to in case you don't), is fabricated in order to cause you to buy or sell stocks.

Since I'm not in the room (with this "news" creation), I'm out of the deal. In that regard, I'm just like you; when the spin begins, you and I are not privileged to know which way the stock is headed.

I've always been impressed with one of Wall Street's classic worriers, Marty Zweig, and I know him to be a Growth-oriented investor, so when I saw him Friday evening in the CNBC Tribute to Louis Rukeyser, it came to mind I should look up his Guru criteria for EBAY, which is on the Nasdaq.com site.

According to the Nasdaq profile: "Martin Zweig is a growth investor with a serious conservative streak. A renowned money manager, newsletter writer and frequent guest on the PBS television series 'Wall Street Week,' Zweig knows that money lost is money that's hard to recoup. Accordingly, he searches for stocks that meet a long host of earnings criteria. Quarterly earnings, for example, should be positive and growing faster than they were (a) a year ago, (b) in the preceding three quarters, and (c) over the preceding three years. Annual earnings should be up for at least the past five years. And sales should be growing as fast as or faster than earnings, since cost-cutting and other non-revenue-producing measures alone can't support earnings growth forever. Finally, Zweig suggests that companies have a price-to-earnings ratio of at least 5 'to weed out weak companies' but no more than three times the current market p/e or 43, whichever is lower. His strategy makes sense for investors who like the potential of growth companies but aren't willing to pay premium prices for them."

BTW, I once met Marty Zweig, at an investment conference in New Orleans, and he told me he hated to travel, where he had to get on a plane and leave his (then young) family at home. He struck me as being one of the real nice guys on Wall Street, of which, in spite of my rants, I know there are many. And honest ones, too.

For EBAY, here is the Nasdaq Guru Report Card for Martin Zweig:

P/E RATIO: [FAIL]
REVENUE GROWTH IN RELATION TO EPS GROWTH: [PASS]
SALES GROWTH RATE: [FAIL]
CURRENT QUARTER EARNINGS: [PASS]
QUARTERLY EARNINGS ONE YEAR AGO: [PASS]
POSITIVE EARNINGS GROWTH RATE FOR CURRENT QUARTER: [PASS]
EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: [FAIL]
EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN PRIOR 3 QUARTERS: [PASS]
EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN THE HISTORICAL GROWTH RATE: [FAIL] EARNINGS PERSISTENCE: [PASS]
LONG-TERM EPS GROWTH: [PASS]
TOTAL DEBT/EQUITY RATIO: [PASS]
INSIDER TRANSACTIONS: [PASS]

Detailed Analysis
Guru Score: 62%

P/E RATIO: [FAIL] The P/E of a company must be greater than 5 to eliminate weak companies, not more than 3 times the current Market P/E because the situation is much too risky, and never greater than 43. EBAY's P/E is 111.52, based on trailing 12-month earnings, while the current market P/E is 24.00. Therefore, it fails the first test.

REVENUE GROWTH IN RELATION TO EPS GROWTH: [PASS] Revenue Growth must not be substantially less than earnings growth. For earnings to continue to grow over time they must be supported by a comparable or better sales growth rate and not just by cost cutting or other non-sales measures. EBAY's revenue growth is 79.01%, while it's earnings growth rate is 112.94%, based on the average of the 3, 4 and 5-year historical eps growth rates. Sales growth is not at least 85% of EPS growth so the initial part of this criteria is not met, however, since both sales growth and eps growth are greater than 30%, that requirement is waived and the company passes this test.

SALES GROWTH RATE: [FAIL] Another important issue regarding sales growth is that the rate of quarterly sales growth is rising. To evaluate this, the change from this quarter last year to the present quarter (51.8%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (51.9%) of the current year. Sales growth for the prior must be greater than the latter. For EBAY this criterion has not been met and fails this test.The earnings numbers of a company should be examined from various different angles. Three of these angles are stability in the trend of earnings, earnings persistence, and earnings acceleration. To evaluate stability, the stock has to pass the following four criteria.

CURRENT QUARTER EARNINGS: [PASS] The first of these criteria is that the current EPS be positive. EBAY's EPS ($0.27) pass this test.

QUARTERLY EARNINGS ONE YEAR AGO: [PASS] The EPS for the quarter one year ago must be positive.
EBAY's EPS for this quarter last year ($0.16) pass this test.

POSITIVE EARNINGS GROWTH RATE FOR CURRENT QUARTER: [PASS] The growth rate of the current quarter's earnings compared to the same quarter a year ago must also be positive. EBAY's growth rate of 68.75% passes this test.

EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: [FAIL] Compare the earnings growth rate of the previous three quarters with long-term EPS growth rate. Earnings growth in the previous 3 quarters should be at least half of the long-term EPS growth rate. Half of the long-term EPS growth rate for EBAY is 56.47%. This should be less than the growth rates for the 3 previous quarters, which are 50.00%, 87.50% and 100.00%. EBAY does not pass this test, which means that it does not have good, reasonably steady earnings.This strategy looks at the rate which earnings grow and evaluates this rate of growth from different angles. The 4 tests immediately following are detailed below.

EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN PRIOR 3 QUARTERS: [PASS] If the growth rate of the prior three quarter's earnings, 79.55%, (versus the same three quarters a year earlier) is greater than the growth rate of the current quarter earnings, 68.75%, (versus the same quarter one year ago) then the stock fails, with one exception: if the growth rate in earnings between the current quarter and the same quarter one year ago is greater than 30%, then the stock would pass. The growth rate over this period for EBAY is 68.8%, and it would therefore pass this test.

EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN THE HISTORICAL GROWTH RATE: [FAIL] The EPS growth rate for the current quarter, 68.75% must be greater than or equal to the historical growth which is 112.94%. Since this is not the case EBAY would therefore fail this test.

EARNINGS PERSISTENCE: [PASS] Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five-year period. EBAY, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 0.02, 0.09, 0.16, 0.43 and 0.68, passes this test.

LONG-TERM EPS GROWTH: [PASS] One final earnings test required is that the long-term earnings growth rate must be at least 15% per year. EBAY's long-term growth rate of 112.94%, based on the average of the 3, 4 and 5 year historical eps growth rates, passes this test.

TOTAL DEBT/EQUITY RATIO: [PASS] A final criterion is that a company must not have a high level of debt. A high level of total debt, due to high interest expenses, can have a very negative effect on earnings if business moderately turns down. If a company does have a high level, an investor may want to avoid this stock altogether. EBAY's Debt/Equity (2.00%) is not considered high relative to its industry (85.33%) and passes this test.

INSIDER TRANSACTIONS: [PASS] A factor that adds to a stock's attractiveness is if insider buy transactions number 3 or more, while insider sell transactions are zero. Zweig calls this an insider buy signal. For EBAY this criterion has not been met (insider sell transactions are 20, while insiders buying number 3). Despite the fact that insider sells out number insider buys for this company, Zweig considers even one insider buy transaction enough to prevent an insider sell signal, therefore there is not an insider sell signal and the stock passes this criterion.

As for me, if you wish to delve right into the investment analysis, here is the info I have on EBAY. I am impressed with the profit margins, etc, but I cannot overlook the almost 1500 times price-to-free cash flow multiple, and the fact that sales and earnings growth in recent quarters is not up to historical averages.

FundamentalsFundamentalsFundamentalsFundamentalsFundamentals

EBAY is a super company, but at any time, investors could get hammered by a change in tactics by a large Wall Street capital trading pool (say five or ten houses working together).

What I might do, if I was long the stock is to write short-term (3 to 4-month) calls whenever I thought the stock was technically over-bought, and to write short-term puts (prepared to buy the stock at much lower prices if the stock was put to me) whenever I thought the stock was technically over-sold.

After a big run up on Dec. 28 near the close, and at the open on the 30th, the %K STO and MACD rolled over. That would have been a good time to write the calls.

Daily

Unfortunately trading is not a matter of "woulda, coulda, shoulda", so you have to know in advance what your position is, both strategically and tactically, and then wait for these conditions to present themselves in markets.

That's the only way you are going to outwit the brilliant minds and computer programmed trading models on Wall Street.

One thing is for sure; when you see an average trading daily volume of greater than 9 million shares (in the $100 price range), which means the average daily trading value is close to $1 billion, then you know Wall Street is all over the stock.

And if you think you are going to beat Wall Street, you had better be pretty good at the trading business.

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Kaushik Gala for the Investment Roundtable
www.galatime.com

E-bay has been in a strong uptrend during the latter half of 2004, and is trading at all-time highs near $118. There have been repeated concerns about valuation, but the stock has been risen steadily amid all the pessimism. With low short interest, analyst opinion, and a moderate put-call ratio, there's not many catalysts for large moves in the stock price. Here's the 3-month chart for Ebay:

Daily

Most indicators (OBV, Money Flow, etc.) are in positive territory, although some are showing signs of decline (MACD, RSI). The ADX at ~30 shows a pause in the steep up-trend - Ebay has been consolidating for much of December, stuck in a range between $110 & $118. This has caused the volatility to drop towards the lower end of its 52-week range. I also looked at option volume data for the past two months, but there's no signs of unusual activity.

Since the stock remains in a bullish trend (and above its 50-dma and 200-dma), I wouldn't consider an outright bearish position. However, with earnings due on Jan 19th, there is a good chance for the stock to breakout of its short-term range, and test its all time highs. I think a call ratio backspread strategy is appropriate for my bullish outlook on Ebay - the best scenario being an upside breakout to the $130 - $150 range.

Sell 1 Apr '05 $110 Call @ $1180 / contract

Buy 2 Apr '05 $120 Calls @ $640 / contract

Net cost to enter the position = $1180 - $1280 = ($100). This backspread has a break-even price at $131, maximum loss of $1,100 and unlimited profit potential.

Risks: A further decrease in implied volatility would increase the losses, as would accelerating time decay. And of course, if Ebay cannot break the $130 level, this position wouldn't make profits. However, the loss can be significantly reduced by closing the position well before expiration (late February/early March).

Exit Strategy:

If EBay is below $125 on Feb 28, close the entire position at a loss.

If Ebay hits $140 at any time, close the entire position at a profit.

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