Overstock.com (OSTK): Part One – An Introduction

All my best ideas were someone else’s ideas first. This gives me no pain. I long ago ceded the thrill of originality to better minds and bigger egos. I’m content to troll through newspapers, screens, blogs, message boards, and the like to collect investing ideas.

But when an interesting idea comes along, I revel in the deep struggle to understand it, handicap its potential, and determine its value. That’s just not work I can (or want to) leave to anyone else.

I found Overstock.com on the “Corner of Berkshire and Fairfax” message board, a Canadian-based homage to uber-investors Warren Buffett and Prem Watsa.  Overstock has been a pet feature of the board moderator since Fairfax made an investment in 2007 and subsequently took a seat as a company director.

It seemed an intriguing gamble by a renowned value investor – taking an equity position in a young company with a track record of losses – so I thought Overstock worthy of a second glance.

As the name lets on, it’s an internet retailer of overstock and surplus items. Patrick Byrne has led the company for ten years. He is the son of Jack Byrne (who has the eternal favor of Warren Buffett for helping lead GEICO through its pre-Berkshire turnaround), and Patrick even worked briefly under the Berkshire umbrella as interim CEO for uniform maker Fechheimer Brothers, Inc. This, plus Watsa’s investment, lends Overstock quite the value investing halo.

I crunch a few numbers and find that Overstock has recently passed the $1 billion mark in sales and produced $14 million in net earnings (only its second full year profit). The market cap is $345 million, giving it a not-so-cheap-looking P/E multiple of 25.

But that’s not what captures my attention. Overstock reached that revenue milestone and produced that profit while maintaining an invested capital base of only $30 million. If you assume it has a normalized tax rate of 23 percent, that’s a return on invested capital (ROIC) of 36 percent. Not bad, especially if earnings are on an uptick.

So, my interest is piqued. I’ve found this company that already has the blessings (and money) of a bona fide value investing legend, it seems like it may have some momentum in revenue and earnings, and it’s building a business on a miniscule amount of capital. Discretion be damned! Let’s invest! A business that can grow without the need for much capital is an investment compounding machine. If…

…Well, “if” the business can continue growing its earnings at a faster rate than its need for additional invested capital. Determining that means taking a hard look into its operations and its competition.

Before we jump into that, however, we’ll use our next installment to ponder the concept of ROIC.