Foolish Forecast: Riding the Digital River

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Doesn't matter what "it" is. If you can sell it online, there's a good chance that Digital River (Nasdaq: DRIV) is helping to process the transaction. After close of market tomorrow, the e-commerce outsourcee reports its Q4 and full-year 2005 earnings.

Wall Street Wisdom:

• General consensus. Ten analysts follow this company, splitting their views straight down the middle: five "buys," five "holds."
• Revenues. The consensus of analysts polled suggests that tomorrow Digital River will report booking 19% more sales in Q4 2005 than it did one year ago -- $57.2 million in all.
• Earnings. Analysts don't expect this to result in increased profits, however. They're looking for Digital River's net earnings to decline to $0.31 per share for the quarter. (Interestingly, even this number is $0.02 more than the company itself predicted three months ago.)

Margin watch:
Digital River's profits are a thing of beauty. The gross rises inexorably as time goes by. Operating margins are up nearly 50% over the past 18 months. And the average net is coming in 340 basis points higher, at last report, than it was a year and a half ago.

Margins%	6/04	9/04	12/04	3/05	6/05	9/05
Gross	85.9	85.9	86.9	87.5	88.1	88.8
Op.	20.1	20.7	22.4	25.4	27.2	29.1
Net	20.5	21.1	22.9	23.6	23.4	23.9

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ending in the named months.

Options watch:
There was a time when I looked seriously at investing in Digital River, but after dipping my toe in the water, I immediately jumped out again, shocked at the company's egregious stock dilution (the share count had amounted to 80% growth in four years). Now I see that dilution has moderated to about 4.5% per annum in recent quarters. That's still not ideal, but it's good enough for a Fool to grin and bear it.

Valuation metrics:
Good enough, especially when you consider just how truly cheap Digital River's stock is looking today. Sure, a P/E of 27 isn't what you'd ordinarily call "cheap." But that P/E is predicated upon accounting profits, which vastly understate this company's actual cash profitability. With a price-to-free cash flow ratio of just 15, and analysts projecting 20% earnings growth for the foreseeable future, Digital River looks to be worth another dip.

Fool contributor Rich Smith does not own shares of Digital River.