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The Long and Short of It: Stay Away From eBay

Do virtual trees grow to heaven? Mutual fund managers seem to think so, if the tree in question is eBay (EBAY - Get Report).

The San Jose, Calif.-based online auctioneer continues to dazzle Wall Street, including Tuesday's better-than-expected results and projections of a 49% rise in earnings. Large-cap fund managers, desperate for stocks with earnings momentum, have herded into eBay: 211 large-growth and large-blend funds, or 20% of the 1,072 funds in the two categories, reported taking a new stake in the company during the past four quarters, according to research conducted by Morningstar for TheStreet.com. The stock is now in 34% of all large-growth and blend funds, up from 9.8% two years ago. And the flock into eBay doesn't show any sign of slowing: The stock is up 5% Wednesday to $93.62.

This "institutional herding" -- when mutual funds flock to a particular stock -- has major implications for investors weighing buying or short-selling eBay. While eBay continues to post growth far beyond Wall Street's expectations, the smart money has bid the shares up to perilously high valuations: Its current price-to-earnings multiple stands at 110; forward P/E is about 60. However, short-selling eBay in the face of stampeding fund managers is a losing proposition.

"It's hard to imagine how a company with a market capitalization of $29 billion can justify that sort of price-to-earnings multiple," said Richard Sias, an associate professor at Washington State University. But Sias, who has written extensively on herding among mutual fund managers, said going short against the stock based on valuation alone might be just as dangerous as going long. "Like Keynes warned, the markets can remain irrational longer than you can remain solvent," Sias said.

The bottom line for investors mulling over a position in eBay: Stay on the sidelines.

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