MercadoLibre Bringing Back Bubble Memories

In the first half of this year, MercadoLibre has done much better, posting a profit of 3 cents a share. Now let's suppose the company doubles that figure in the rest of the year. Its P/E is still 411 for 2007.

Merrill Lynch justified its $35 price target by valuing the stock at 46 times earnings for the year ending December 2009. In other words, MercadoLibre will fall to a valuation (one that most sensible investors are uncomfortable with) not this year, or even next year, but according to an earnings report that may not come out until March 2010.

I'm not knocking MercadoLibre, which is clearly poised for growth, and it's even possible these predictions may come true.

In its IPO prospectus, MercadoLibre said that economies of scale would push up its operating profit, and that's exactly what happened in the second quarter. Operating margins were 25%, up from both 18% in the previous quarter and 12% in the second quarter of 2006 (See page 13 of this investor presentation).

But valuing a stock according to an expected profit two or three years down the road isn't fundamental analysis , it's speculation. And it's the kind of speculative rationalization that we really haven't seen in the Internet sector since the waning days of the bubble.

What if eBay, which owns 18.5% of MercadoLibre, decides to set up shop in Latin America? That would cut MercadoLibre's revenue and drive up marketing costs, eroding profit margins. Remember, eBay recently began competing with Craigslist, a company in which it also owns a stake.