Should You Join This Insider In Buying eBay?

| About: eBay Inc. (EBAY)

By Matt Doiron

A Form 4 filed with the SEC has revealed that Kathleen Mitic, a member of eBay (NASDAQ:EBAY)'s Board of Directors and a former executive at Facebook, purchased 5,000 shares of eBay on July 24th at an average price of $51.61 per share. She had not owned any shares directly prior to this purchase. Investing over $250,000 in eBay is an increase in her company-specific risk, and economic theory states that company insiders should generally prefer to diversify their wealth unless they are more confident than usual in the stock's future prospects. Insider purchases are therefore often treated as bullish signals, and in fact studies generally show a small outperformance effect for stocks bought by insiders (read our analysis of studies on insider trading).

In the second quarter of 2013, eBay experienced 14% revenue growth versus a year earlier led by strong results in the payments segment (which includes PayPal). Margins did shrink, however, and so operating income only grew by 8% (reported earnings were lower than in Q2 2012 due to a gain on sale in the prior year period). Following a strong first quarter of the year operating income is now up 15% year to date.

With a market capitalization of $66 billion, eBay is valued at 25 times its trailing earnings. That valuation certainly prices in high growth over the next few years, although Wall Street analysts do expect the company to do well going forward. In fact, the forward P/E is only 16. We would note that the payments business tends to have a lower operating margin than the marketplace operations, and so if eBay's revenue growth continues to be driven by that division of the company we would expect operating margins to continue to decline- therefore increasing the levels of sales growth the business has to achieve in order to generate enough future earnings to justify the current valuation.

In addition to insider trading activity, we track quarterly 13F filings from hundreds of hedge funds and other notable investors. We've found that this information can be useful in developing investment strategies (for example, the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year). According to our database, EBAY was the 9th most popular stock among the 500 hedge funds we are tracking (see the most popular stocks among hedge funds at the end of March).

Peers for eBay's online auctions business include Amazon (NASDAQ:AMZN) and (NASDAQ:OSTK). Amazon is valued at about 100 times forward earnings estimates, and just reported an unexpected quarterly loss; the company has now missed consensus earnings in three of the last four quarters. Expenses continue to rise, casting doubt on bulls' insistence that Amazon will soon be able to trim many of its costs and immediately realize high profits. As a result we would avoid the stock. Overstock has been delivering high growth on both top and bottom lines, going by recent reports, and is up over 300% in the last year. Those are eye catching returns, though they have brought the company's earnings multiples up fairly high and 28% of the float is held short as many market players expect that growth rates will soon fall.

Paypal can be compared to more traditional money wiring services including Western Union (NYSE:WU) and Moneygram International (NYSE:MGI). Western Union's business has been weak recently, with earnings down over 10% from their levels a year ago off of modest declines in revenue. The stock is priced in what would be value territory (for example, the forward earnings multiple is 11) if management was keeping the financials steady but even the sell-side is predicting further decreases in profit. Its smaller peer Moneygram is priced at a small premium to it on a forward earnings basis, with a P/E of 14, and while sales have actually been up according to that company's recent results we are skeptical that this would continue for the longer term given shifts in the industry.

As a result we are skeptical of the value proposition that many of these peers offer investors, although Western Union would certainly be appealing if the company managed to cut costs enough in the future to hold earnings steady. eBay itself, even with the insider purchase, seems a bit pricey at current levels and while we do like the prospects of the payments business we've mentioned our concerns that a shift in revenue mix towards those operations may reduce margins.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article is written by Insider Monkey's writer, Matt Doiron, and edited by Meena Krishnamsetty. They don't have any business relationships with any of the companies mentioned in this article and they didn't receive compensation (other than from Insider Monkey and Seeking Alpha) to write this article.