It’s “Readers Choice” again here at Stock of the Week!

And this week we’re looking at a well-known e-commerce giant.

The company is a cash-flow machine – one of the best I’ve seen according to my No. 1 metric, cash return on capital invested (CROCI).

But the stock’s price has seen some huge gains and some huge drops over the past couple of years.

Will the volatility continue… and if so, is there good news for investors who can stomach the ride?

The answers are all in my latest video. Click on the image below to watch it.

Transcript

Hi, everyone, welcome to another Stock of the Week. Also, you’re friends of mine now, so welcome to my home. I’m hidden away here at the moment, doing the Stock of the Week for you.  

As you know, I’m Alpesh Patel. I’m a hedge fund manager. And with this Stock the Week, I’ve picked one that you’ve written to me about that you want me to analyze.

And I love doing that. Because it makes us closer and more engaged with each other, and it allows me to really, genuinely, make sure I’m doing something that helps you.  

So the one I’ve picked this week, I’m sure it’s one many of you know and have come across. It’s MercadoLibre (MELI).

For those of you who don’t know the company, and as I say, I’m sure most of you do, it’s the largest e-commerce marketplace in Latin America. It connects more than 132 million buyers and 1 million sellers across 18 Latin American countries.

It generates revenues from final value fees, from advertising royalties, payment processing, all sorts of things. Subscription fees, interest income from consumer and small business lendings. And as you can imagine, also diverse revenue streams, big footprint, an important region. The company’s been around since 1999, headquartered out of Argentina.

As I said, one of you has asked me to comment on it, and my analysis. Now the first thing that comes to mind is this; it’s volatile. The share price is volatile. It had this amazing run up a couple of years ago, where it went from about $500 to $2,000. Then, it’s almost like Bitcoin. Then falls back from 2000, all the way to below $1,500, and then goes back up to $2,000. And now it’s halved. So we’ve had a 50% drop in 2021. And that I assume is why I’ve been asked the question, what’s the outlook for it? Massive 50% drop.

Okay. Essentially going from, like I said, $2,000 to $1,000. If you take together, sorry, I shouldn’t just say 2021. If you take 2021 and 2022 to date. So whilst in 2019 it was up almost 100%, in 2020 it was up almost 200%. And back in 2017, it was up 100%. So it’s had some big, 100%-plus years. Obviously, some people have got in late, or they’ve given up a lot of those gains and they’re wondering, well, am I going to get another 100% year? When’s it going to come?

And there’s several things I want to say about this one. Let’s talk about the positives: cash flow. This is a cash-flow machine. The cash return on capital invested, the amount of capital invested and the cash flow it generates is 27%.

Now, those of you know me know that that’s an important metric for me. Because it’s the metric that I’ve taken from Goldman Sachs, who uses it for their wealthiest clients. And they know that companies in the top 10%, actually top 25% of companies by cash return on capital invested tend to generate on average about a 30% per-annum return.

But look at the volatility of that. Yeah, you might get your 30% per-annum return over those five years, but you’ve had a 200% return, a 100% return, but down 50%. And so swings, and roundabouts and that.

So the cashflow is great.

The Sortino, which is a measure of return for volatility, is 0.6. Now it’s above a half, which is sort of my threshold. Ideally I want it above 1. It’s a measure of the rewards you’re getting. So, your 300% returns, aligned for the massive volatility.

And the reason it’s still above a half is because when the ups are good, they’re huge. They’re phenomenal. And when the downs are bad, well, okay, 50% loss is not too bad when you’ve had a 200% gain.

It definitely outperforms the market. But the volatility of the stock, 38%. It’s one of the most volatile companies that I’ve come across. Okay? And if you don’t like that rollercoaster ride, you’re probably not going to like this company.

If you don’t mind the volatility, and you’re willing to take a long enough view, because you’d have to take a long-term view if you’ve got that kind of volatility, then probably if you were to draw a trend line from where it’s been going up since 2017, you’d say it might be about to go on to a slower rate of growth. Which means it could still fall back a bit more, but it should be ultimately upward trending.

So we’re talking about a company which is likely to continue growing. The problem is it could fall back more, and then the rate of growth be relatively slow. So for you to make your money back on any drops you’ve had already might take a bit of time, but that’s not to say it’s not a good long-term hold.

Why do I say it’s not a bad long-term hold? Well, as I said, in terms of quality measures, return on equity, return on capital invested, return on cash return on capital invested. Free cash flow conversion, the ability to generate free cash flow, earnings, forecasts, sales forecasts, all of these look strong.

And it’s for those reasons that I think it’s a solid company. The only sort of problem we’ve got at these levels, still even though it’s dropped 50%, is price/earnings. Valuation, basically. It still is arguably overvalued. So it doesn’t quite fit into what I would look for. But for those of you who like higher risk, more volatility and overvalued companies, then it might fit in there.

Thank you very much.