Why a value investor writing about an internet company profitable? Because the value of investment is about finding dollars that trade for fifty cents, with a market capitalization of less than 75% of sales, Overstock. com (OSTK) seems to be exactly that.

But it is too risky?

The greatest risk of any investment is the risk of overpaying. So the real question is: what is Overstock is it? I think it is worth at least $ 1. 5 billion. With a market capitalization of the meeting Overstock currently about 500 million dollars, my assessment seems very absurd. However, there is only one way to know for sure. Let's disarm the argument of my piece by piece and see if any of my assumptions are reasonable.

Hypothesis: Over the next five years, Overstock, and will not generate free cash flow of the truth, or consume cash. In other words, their margin of free cash flow will average 0%. Cash generation in some years exactly offset cash expenditures in other years. Obviously, this assumption is reasonable because there is almost no chance that the cash flows exactly offset.

This is not a problem if it turns out that Overstock does generate some cash flow over the next five years. In this case, my assumption is simply wrong on the side of caution. If, however, Overstock is actually consumes cash over the next five years, there is a problem – maybe a big problem. So the scenario is more likely?

Overstock revenues are growing rapidly. Gross margins look solid in 13. 3% in 2004 and 14. 9% over the last twelve months. Overstock lack of profitability is the result of its selling, general and administrative (SG & A), which have grown exponentially. Are these costs continue to rise? Yes, but not as fast as income. Over the last twelve months, spending limits Overstock start was 5. 6% of sales. This number is an aberration. In the long term costs of the CAP EX should not exceed 3% of sales. Taking into account the company is in surplus and the expected sales growth, the company most likely not generate free cash flow over the next five years. Thus, the assumption that Overstock will be cash flow neutral over the next five years is not too optimistic.

Second scenario: In the next five years, sales of Overstock increase of 15% per year. Is this a reasonable assumption? Again, I do not think it is. Very few industries should grow faster than e-commerce. Revenue growth from Overstock in 2003 and 2004 was over 100%. Last year, growth has slowed. However, it is still closer to 50% of which is 15%. Overstock is a cyclical business. Therefore, there is no reason to believe that current sales are abnormally high.

In addition, all that is advertising spending consumer awareness to excess. A review of traffic data Overstock shows that not only won more visitors, but also increased the ranks of the most popular. If it is a long, long way from Amazon, eBay and Yahoos of the world (and never reach the heights) Overstock is a well known destination on the Internet. This was particularly evident in the weeks preceding Christmas. Overstock buyers who visited during the holiday season, I know it exists, and May and return at another time of year. Analysts predict that high growth rates for Overstock, however, also recommends selling the stock. Do not put any weight on his estimates. But for other reasons, I think the assumption that Overstock will grow sales by 15% per year over the next five years is unreasonable.

Third Assumption: Six to ten years from today, Overstock will have a margin of free cash flow of 3%. Ten years from today, Overstock margin free cash flow increased by 4% and remain at that level. Now, all the assumptions I made, it is more debatable. Of course, Amazon has that kind of margin of free cash flow, but not Amazon Overstock, and will never be the Amazon. Overstock's gross margins of the Amazon. In fact, Overstock's gross margins that Wal – Mart. However, the fixed costs of overstock eating a much smaller portion of its sales in the case of Wal – Mart.

Overstock Compared to other online retailers, you'll find that if you encounter Overstock strong sales growth, margin of 3% of free cash flow of six years from now is not reasonable. I figured Overstock margin sustainable free cash flow will be 4%. There is a situation of being only 4% is too high. I will not make that case, I think not. Remember that 4% number comes ten years. This gives a lot of time surpluses increase sales and reduce operating expenses as a percentage of sales.

Fourth hypothesis: Six to ten years from today, Overstock will grow sales by 12% per year, eleven to fifteen years from today, Overstock will grow sales by 8% annually thereafter Overstock will grow sales by 4% per year. Let's see what this really means. Under these assumptions, sales Overstock is as follows:

Today: 707 million U.S.

2011: $ 1. 59 billion

2016: $ 2. 71 billion

2021: $ 3. 83 billion

2026: $ 4. 66 billion

2031: $ 5. 67 billion

2036: $ 6. 90 billion

Seven billion dollars is not an unreasonable goal – if you have thirty years to accomplish. To put this in perspective, the Amazon. com currently has sales of approximately $ 8 billion. Thus, even after thirty years, these assumptions do not lead Overstock reach the same size as the Amazon today. Remember that these figures imply some inflation. For example, if inflation averaged 3% per year over the next thirty years, Overstock projected $ 6. 90 billion in revenues translates into only $ 2. 84 billion dollars today. Therefore, these assumptions only lead to a quadrupling of actual sales of overstock for a period of thirty years. I think it is quite reasonable.

If you take these four cases together, we obtain a value of $ 1. 5 billion for Overstock. Today, Mr. Market is offering 500 million dollars – that's why I am writing about a profitable Internet company.