Overstock.com's Infinite Battle

E-commerce discounter Overstock.com (NASDAQ: OSTK  ) received a sharp jab on Monday as the company released an earnings report that, while showing decent growth, just couldn't keep pace with market expectations. The company operates in an e-tailing niche -- discounted, off-brand, and closeout merchandise -- which gives it some protection from the 800-pound gorilla in the space. The question remains, though: How far can Overstock progress in the shadow of Amazon.com (NASDAQ: AMZN  ) . Is there a reason to buy the freshly discounted shares of Overstock? Let's take a closer look at recent earnings for clues.

Earnings glance
Overstock.com shares went tumbling on Monday, even though earnings (in isolation) looked OK. The company saw third-quarter sales rise by 18% to $301.4 million, with a bottom-line gain of 27% -- $0.14 per share versus $0.11 per share in the year-ago quarter. Gross margins improved by 160 basis points, though the company's sales and marketing expense ticked up substantially: 51% higher than the year-ago quarter.

The heightened marketing spend may have something to do with the company's new loyalty program, Club O. The new initiative is clearly one intended to fight back against Amazon's comprehensive Amazon Prime membership. Club O gives customers free shipping (noticeably absent of the two-day element found in Amazon Prime) and 5% to 25% customer reward discounts, all for $20 per year.

Overstock.com also launched a new warehouse in Pennsylvania in hopes of speeding up delivery times. Again, this seems to be an effort to address some of the more appealing elements of shopping via Amazon.

In the past 12 months, the company generated just under $40 million in free cash flow.

Unimpressed
The stock slid because the Street just wanted more out of the company -- but really not that much. Overstock only missed by one penny on EPS, and actually met top-line estimates. Why, then, the substantial sell-off?

It's hard to say, really, other than that investors and analysts aren't quite sure the company can maintain its moat without encroachment from the industry giant. Overstock is growing well into the double digits and has very respectable margins. The loyalty program will likely aid customer retention and perhaps acquisition. Cash flows are respectable for an Internet company with a $600 million market cap. Valuation isn't even that atrocious at roughly 26 times forward earnings estimates. For comparison, Amazon trades at more than 100 times its forward earnings. Overstock could be viewed as the cheap, contrarian play to e-commerce. But should it?

Though it operates solely online, the company faces an old issue first experienced by smaller retailers when Wal-Mart rose to power. Amazon can meet or beat Overstock pricing, even though the latter is known as the discounter. Amazon's supply chain is unmatched; its distribution is top-tier, and its moat as the final stop for all things Internet retailing is simply impermeable. Whatever Amazon waltzes into, it can probably make work simply by virtue of its scale. Despite Overstock's impressive efforts, the company has an eternal uphill battle ahead.

At a cheaper price, Overstock would be a compelling company to own. It's well managed and has all of the aforementioned qualities. But even at 26 times forward earnings, it isn't cheap enough. Amazon's valuation is irrelevant as the company is just unstoppable, so investors shouldn't stress comparisons that heavily. This isn't to say that Amazon is a great investment today, but it doesn't mean that Overstock will catch up any time soon. Wait for the market to take even less of an interest in the stock, and then consider a discounted buy.

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