Market Equilibrium, Ebay, and Love …

Today a reader asked me a question. I replied to her via email, but unfortunately the email bounced back:

I just read the essay about the equilibrium in a market. Would you consider ebay as a market where this “ideal state of equilibrium” is achieved? Or are market equilibriums never achieved in real life?

My response:

Hi Christina,

Thanks much for this great question.

The market equilibrium I refer to is really never lastingly achieved in real life.

See, all events that occur on the market are processes. We always act in order to remove one or the other uneasiness in our lives. This is evident in the very fact that we act.

On ebay you constantly find people who prefer owning cash to owning a pair of shoes and you will find people who prefer owning shoes to owning cash. This is the reason why ebay exists in the first place, right? Ebay woudn’t exist if the market had reached the theoretical state of market equilibrium.

What I would say about ebay is that it is a great facilitator of the process of moving toward the theoretical state of market equilibrium more quickly. This targeted state, however, remains in constant flux.

The closest I can think of where a “market equilibrium” of sorts is reached is two people falling in love. When you fall in love, for a brief moment you feel like things can’t get any better. You are above all things and you wish nothing would change. But, as it is with human nature, we fall out of love after some time and that is when the real process of loving can be actively pursued … :)

Let me know if you have any more questions!

Best regards,
Nima

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Stock Valuation – Ebay

Below we shall evaluate a fair stock price for Ebay.

Free Cash Flow per Share:

  • EBAY’s FCF over the past 4 quarters was $2,456,160,000
  • EBAY has shares outstanding of $1,280,000,000
  • Thus the Free Cash Flow Per Share is $1.92

Annual Growth Rate:

  • From 2004 through 2007 Ebay has been growing at an average annual growth rate of 32%
  • Through 2008, free cash flow has been declining slowly from quarter to quarter, but remains remarkably strong in light of the current economic woes
  • The slowdown in overall consumer credit will certainly hurt ebay
  • However, it needs to be pointed out that EBAY is not a seller of products, ebay is a business that facilitates auctions between buyers and sellers; as individuals consolidate their finances they will sell more items on ebay; thus I expect this consolidation effect to counterbalance or at least dampen the effect of the decline of overall consumer demand.
  • EBAY is also well positioned internationally and derives a significant portion of its income abroad, balancing our the negative effects of dollar weakness to the shareholders
  • EBAY has a remarkably high ratio of shareholder’s equity to debt of 10:3, where all liabilities are short term liabilities such as accounts payable and $0.00 in long term debt, virtually shielding it from the current financial crisis
  • To be safe we shall assume that EBAY’s FCF will remain stagnant over the next 5 years and rise at a perpetual rate of 1% thereafter

Confidence margin:

  • Due to high volatility over the past 4 years, we shall apply a confidence margin of 50% to this profit expectation

Price:

  • Applying the valuation formula to the assumptions stated above, EBAY’s fair stock price computes to $108.73
  • It is, without a doubt, very reasonable to be bullish for EBAY at its current price of $14.45

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