When researching stocks it is important to keep an open mind. In an age where information and opinion is freely (some might say too freely) available, it is usually possible to justify a pre-conception. In a perfect world that wouldn’t happen, everybody would start with an objective analysis of available data and come to a conclusion. In reality, however, most research is prompted by an opinion.
If one keeps an open mind, however, that opinion can change. I started to look at eBay (EBAY) stock as part of a general idea about how underperforming stocks in bull markets can be traps for investors. There has often been no drastic move to the downside, rather the stock has bounced around in a range and can look attractive. The failure to keep up with a buoyant market, however, can be a serious red flag. Maybe I will write that article one day, but this morning I got distracted.
When looked at on a one month chart, eBay seems to fit the profile of an underperforming stock in a rising market.
A look at the one year chart for the stock gives some hint as to why.
The two blue vertical lines represent the last two earnings release dates for the company, April 17th and June 17th. Both times, expectations were high going in to the numbers, but the company disappointed the market. In fact, if you look at Nasdaq.com's earnings surprise page for EBAY, earnings matched or beat expectations both times, so it wasn’t earnings themselves that caused the stock to collapse each time. This is the type of thing that mystifies and frustrates those new to the market, but the reason is not that hard to find.
In April and June, revenues were a little light, but what worried traders was the company’s forward guidance; they hinted at reduced revenues, particularly from overseas. The reaction was so swift and severe simply because expectations had been high and the stock had run up a long way leading into the disappointment. When most of the market is long even mildly negative news can cause a violent reaction in the stock.
As I said, I was looking to confirm my suspicion that EBAY had run out of steam and this pattern of “volatile stagnation” was a warning sign. Then I came across this; a short report of an agreement between EBAY and Argos, a UK retailer to try offering EBAY customers a collection service. It may seem strange to US readers who like the convenience of home delivery but in Europe collecting an online purchase from a conveniently located store makes sense as shipping costs are high.
Whether this particular program is a success, however, is not the point. Rather it is that EBAY, faced with a challenge to revenue forecasts for Europe is not idly standing by, they are seeking a solution. Of course, EBAY is not just about their core online auction site. Fully 40% of revenues come from Paypal, and the company also owns Stubhub, probably the best known online event ticket broker. Paypal’s revenues and those of eBay do, however, tend to be correlated for obvious reasons.
My hesitation at recommending EBAY to buyers is that it is, as you can see from the chart above, near the top of a well established range. I would certainly look to buy on any move back closer to the $50 base, but a case can be made for buying now. If past performance is any guide, the stock is likely to appreciate over the next few weeks as the quarterly earnings report approaches. There may be some hesitancy this time on a “twice bitten” basis, but an upward move in the next few weeks looks likely.
After two quarters of negative revisions to forward guidance I don’t believe another pessimistic forecast is likely. The global economy has not been on fire, but there has been steady growth. If the bad news is over, then investors will again see EBAY as a growing, profitable company.
Markets are prone to exaggeration. Expectations are powerful things and when they are dashed, there can be a tendency to react too far in the other direction. This natural pattern could explain two things about eBay. First, the company’s guidance itself looks to have shifted from overly optimistic to overly pessimistic. Second, the market is used to having their expectations dashed after the last two quarters, so even a fairly neutral report from eBay next month could produce a significant relief rally.
EBAY looks to have a limited, controllable downside given the significant support at around $50 and a decent upside, even on fairly average numbers. What started out as an article on why investors should be wary of the stock has ended up as a recommendation. It’s a funny old world.