Overstock Is on Discount

Despite having a comparable operating structure (e.g., gross margins) to Amazon(AMZN Quote), Overstock has used a tiny fraction of the capital that Amazon used, to build a comparable amount of business. During the past four years of rapid growth, operating losses have averaged about 3% of sales at Overstock. During the rapid growth phase at Amazon, operating losses averaged well over 20%.

When Amazon was nearing $1 billion in sales a few years ago (as Overstock is today), it took on well over $1.4 billion in debt to fund its expansion. Overstock has built a comparable base of business, with a comparable operating structure, with long-term debt of only $75 million. Long after the controversy over the hedge fund lawsuit dies down, business students will be studying this story. They can call it "Building a Billion Dollar Business on a Shoestring."

Critics of Overstock harp on the fact that the company is not making a profit. This criticism is misplaced. There's more to business value than short-term earnings. Companies with low P/E ratios can be expensive, and companies with no earnings at all can be cheap.

Consider Ford, which was being called "a steal" and "the ultimate no-brainer of an investment" in 2000 because it was selling at less than eight times earnings. Since that time, Ford shares have declined by 70%.

Certainly, the value of Overstock will eventually turn on its ability to generate cash earnings. Although the earnings leverage in this model is considerable, the near-term imperative should be maintaining and building on its dominant market position in this winner-take-all category.

Valuation of Overstock Shares

Since Amazon came public in 1998, it has never traded below one times sales, with the exception of 2001, when it was hit by a wave of negativity. At the time, the company was losing 12% at the operating line and had disappointing sales growth. It briefly traded at $5.50 per share, or 0.75 times sales. Currently, Amazon trades at over $36 per share, or 1.8 times sales.