eBay Inc. (NASDAQ:EBAY), founded in 1995, is the world’s leading provider of shopping and payments on the web. San Jose, California-based company connects a diverse community of individual buyers and sellers as well as small businesses around the world. The company has 2 segments: Payments segment (PayPal) and Marketplaces segment (eBay). Today, the company has more than 94 million active users worldwide.
As of Sep 6, eBay stock was trading at $29 with a 52-week range of $23.38 – $35.35. It has a market cap of $36.7 billion. Trailing twelve month P/E ratio is 22.2, and forward P/E ratio is 12.3. P/B, P/S, and P/CF ratios stand at 2.3, 3.7, and 12.2, respectively. The 3-year annualized revenue and EPS growth stand at 6.1% and 75.9%, respectively. Operating margin is 21.5%, and net profit margin is 17.4%. The company has a low debt-to-equity ratio of 0.1. eBay does not have a dividend policy yet.
eBay has a 4-star rating from Morningstar. While its trailing P/E ratio is 22.2, it has a 5-year average P/E ratio of 43. Out of 31 analysts covering the company, 13 have buy, 3 have outperform, 14 have hold, and one has sell ratings. Wall Street has diverse opinions on eBay’s future. The bottom line is -2.5% growth, whereas the top-line growth estimate is 24% for the next year. Average five-year annualized growth forecast estimate is 12%.
What is the fair value of eBay given the forecast estimates? In this article, the 26th in the series, I will show a step-by-step calculation of eBay’s fair value using discounted earnings plus equity model.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E_{0} + E_{1 }/(1+r) + E_{2 }/(1+r)^{2} + E_{3}/(1+r)^{3} + E_{4}/(1+r)^{4} + E_{5}/(1+r)^{5 }+ Disposal Value
V = E_{0} + E_{0 }(1+g)/(1+r) + E_{0}(1+g)^{2}/(1+r)^{2} + … + E_{0}(1+g)^{5}/(1+r)^{5} + E_{0}(1+g)^{5}/[r(1+r)^{5}]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E_{0}(1+g)^{5}/[r(1+r)^{5}] = E_{5} / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.
eBay’s Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.
Since we are in the middle of the year, it will be more feasible to take the average of ttm EPS of $1.32 along with the mean estimate of $2.32 for the next year.
E_{0 }= EPS = ($1.32 + $2.32) / 2 = $1.82
Wall Street holds diversified opinions on eBay’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 12%. Book value per share is $12.58.
The rest is as follows:
Fair Value Estimator | ||
V0 | E_{0 } | $1.82 |
V1 | E_{0 }(1+g)/(1+r) | $1.84 |
V2 | E_{0}((1+g)/(1+r))^{2} | $1.85 |
V3 | E_{0}((1+g)/(1+r))^{3} | $1.87 |
V4 | E_{0}((1+g)/(1+r))^{4} | $1.89 |
V5 | E_{0}((1+g)/(1+r))^{5} | $1.90 |
D | E_{0}(1+g)^{5}/[r(1+r)^{5}] | $17.30 |
BV | Equals | $12.58 |
Fair Value Range | Lower Boundary | $28.47 |
Upper Boundary | $41.05 | |
Potential | 41.56% |
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5 year discounted-earnings-plus-book-value model, the fair-value range for eBay is between $28.47 and $41.05 per share.
As of Sep 6, eBay was trading at a price of $29. I like eBay as a company. Its websites allows me to get products easily, quickly and safely. I still see a great growth potential, as well. The market more-or-less priced this potential. The current price of $29 reaches the lower boundary of my fair-value range. The stock has 41.56% upside potential to reach the upper boundary of its fair-value range.
O – Metrix Confirmation
If the math above looks too complicated for you, try estimating the fair value using the O-Metrix as such:
O-Metrix = [(Dividend Yield + Growth Estimate) / (P/E Ratio)] * 5
- Dividend Yield: Higher is better.
- EPS Growth: Higher is better.
- P/E Ratio: Lower is better.
The back-testing of this valuation technique on 40 large-caps shows that O-Metrix works very well over the long-term, such as five years. I am also continuously checking on specific sectors, and the formula works very well so far.
What is the O-Metrix Score?
- eBay does not have a dividend policy. Therefore, the yield is 0.
- Growth estimate is the same as the discounted earnings model and is equal to 12%.
- Since we are at the middle of the year, taking the average of ttm (22.2) and forward (12.3) P/E ratios will smooth the results. Thus, the average P/E ratio to be used in the model is 17.25.
O-Metrix = [(12 + 0) / (17.25] * 5 = 3.48
Depending on the benchmark chosen, the market has an O-Metrix score range between 4 and 5. eBay's O-Metrix score of 3.48 is below the fair-value range. Back-testing of this ranking system shows that companies with higher-than-average O-Metrix scores beat the market with lower volatility. At a price of $29, the company is trading within the D-Grade, below-average-return zone.
(Click to enlarge)
Summary
eBay’s stock has always been priced at a premium due to its high growth potential. The average P/E ratio in the last 5 years was 43. As of September 6, the stock is trading with a relatively lower P/E ratio of 22.2, and a forward P/E ratio of 12.3. In the last 5 years annualized EPS growth was 11.81%. With an ever increasing demand for online shopping, I expect the growth to keep its pace.
As of Sep 6, eBay was trading at $29, at the lower boundary of my fair-value range of $28.47 and $41.05. The stock has low total debt/equity ratio of 0.1, but it has a high Beta of 1.55. The stock has 41.56% upside potential based on 12% EPS growth estimate. Analysts are pretty bullish on the stock. The mean intermediate target price estimate is $38.71, implying significant upside potential. Nevertheless, I would wait until earnings confirm the high growth expectations.
You can download FED+ Fair Value Estimator, here.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.