This Online Retailer Rules the Market

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With the holiday season upon us, many consumers are faced with two options for their gift shopping. Option 1: Brave the cold weather and slick streets to make their way to several different gift shops and big box stores to find the perfect gifts for everyone on their list. Option 2: Stay nice and warm and order everything from their couch through online retailers.

Online retail is becoming the way people shop. Occasionally it’s nice to be able to see something in person before you buy, but for most things, online ordering is fine. On Black Friday, online sales surged to more than $1 billion for the first time in history. (NASDAQ: AMZN) had more than 57 million unique U.S. visitors. Cyber Monday was an even bigger success for online retailers, with sales growing 30.3% over the year before.

Online sales growth is expected to be in the double digits for the foreseeable future. There are several great online retailers one could invest in, but there’s one company that makes the rules – eBay (NASDAQ: EBAY).

In The Motley Fool's Rule Breakers, Rule Makers, Fool co-founder Tom Gardner laid out the specific criteria for a “rule making” company. I’ll go through each of them one-by-one, and see how eBay stacks up to Tom’s criteria and the competition.

Mass-Market, Repeat Purchase of Low-Priced Goods

Essentially, eBay’s main business sells advertising space in its online market place by taking a commission from every sale made through its website. With well over 180 million auctions currently running, the market is large. It also runs the popular online finance service PayPal. Over 100 million internet users prefer to use PayPal to send money to others via email, and it’s used to process 95% of eBay purchases.

I consider prices low, as listing prices are mostly determined by the starting and ending price of an auction. PayPal charges a flat fee to transfer funds to a bank account, but no fee to keep funds in the PayPal account to use for future online transactions. Additionally, there is no fee to send funds.

Gross Margin

According to Tom, Rule Makers have a gross margin of at least 60%.

eBay trounces this benchmark easily. The company has maintained a gross profit margin of 70.1% over the last twelve months. However, one should note that gross profit is shrinking. It was 82% in 2005. The company is aggressively growing and investing, but investors may want to keep an eye on this mark. Of course, a 70% gross margin is nothing to sneeze at.

  • Amazon, which has notoriously low margins, has just 23.7% gross profit margin in the trailing twelve months.
  • (NASDAQ: OSTK) does even worse with a gross margin of just 17.5% in the last twelve months.

It’s important to note that eBay operates slightly differently than these two competitors. Instead of holding inventory and shipping, it merely provides advertising space for retailers. Therefore, perhaps a good comparison would be online advertising giant, Google (NASDAQ: GOOG).

  • Google just met the benchmark, posting exactly 60% gross profit for the trailing twelve months. Furthermore, the company has beaten the 60% benchmark each of the last four years.

Net-Profit Margin

Tom says Rule Makers have a net-profit margin above 10%.

In the last twelve months, eBay reported a net profit margin of 28.5%. What’s more, this number is consistently above 20% for the company.

  • Amazon has posted a net profit margin of just 0.1% over the trailing twelve months, with a negative net income from the most recent quarter. Historically, the company posts a net profit margin around 3%.
  • Overstock earned a net profit margin of 0.2% in the last twelve months, and has fluctuated from negative to positive earnings in recent history.
  • Google earned a net profit margin of 22.2% over the past year, and also historically posts numbers above 20%.

Sales Growth

Top-tier Rule Makers grow their sales by 10% every year according to Tom.

Yet another criteria where eBay is outshining the lofty benchmarks as the company has posted sales growth of 27.3% over the last year. The company has grown sales on average 14.3% over the last five years.

  • Amazon is growing even faster. The company grew sales a whopping 40.6% over the last year, and a fantastic 35% over the last five years.
  • Overstock, on the other hand, is seeing its sales shrink. This year sales are down 3.3% after being down 1.6% the year before.
  • Google, too, is moving in the right direction with 29.3% sales growth this year, in line with its five year average of 29%.

It’s interesting that eBay is actually lagging the competition in terms of sales growth. The 10% benchmark is just a guideline, for some industries it ought to be higher. Perhaps online retail, with its excellent growth in recent years, should be near 25%. eBay meets that mark this year, but historically, it’s lagging.

Cash-to-Debt Ratio

Ideally, Rule Makers will have more cash than debt. The best Rule Makers have at least 1.5 times more cash than debt.

With $7.3 billion in cash and $4.5 billion in debt, eBay passes the benchmark with a ratio of 1.6.

  • Amazon is in the enviable position of having no debt. Therefore, it has the best cash-to-debt ratio possible.
  • Overstock has $17 million in short-term debt, but has plenty of cash on the balance sheet to cover with $60 million resulting in a ratio of 3.5.
  • Google has $16.3 billion of cash and just $6.2 billion of total debt for a good cash-to-debt ratio of 2.6.

Here is another category where eBay lags even its weakest competition. However, the main idea behind this criterion is that the company has more than enough cash to manage its debt position. With debt being so inexpensive in today’s market, this is definitely an acceptable level of debt.

Foolish Flow Ratio

The foolish flow ratio is a measurement of how well a company manages its inventory and cash. The lower the number the better, but the acceptable upper limit is 1.25.

This criterion is a little different for eBay because it doesn’t carry inventory. Therefore, it’s more of a measurement of how well the company manages its cash and receivables. eBay has a Foolish Flow ratio of 1.17, just under the benchmark of 1.25.

  • Amazon has an excellent ratio of 0.62. Since, Amazon operates more like a traditional retailer, and carries an inventory, this is a fantastic sign of great inventory management.
  • Overstock does Amazon one better, positing a Foolish Flow ratio of just 0.41. The company has relatively high levels of cash as a percentage of its current assets, and manages inventory well.
  • Google has a Foolish Flow ratio of 0.77. The company has a small amount of inventory, which makes up just 1% of current assets.

Your Familiarity and Interest

Most online shoppers are quite familiar with eBay. As I mentioned earlier there are hundreds of millions of PayPal users and auction bidders every day. The company is ubiquitous with online auctions, and hosts over 30 times as many auctions as its leading competitor eBids. The website makes shopping and selling relatively painless with its integration of the company’s PayPal product.

Online Retail Rule Maker

eBay passed Tom’s benchmark on every criterion. It should be noted that eBay operates differently from most online retailers, but is still a hub for online shopping. The company is more of an advertising company for independent sellers. As an online advertiser, eBay compares favorably to internet giant Google in some categories, but Google clearly outshines it overall. Nonetheless, eBay is a strong investment, and is the rule maker for online retail.

adamlevy owns shares of The Motley Fool owns shares of and Google. Motley Fool newsletter services recommend, eBay, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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