World's Scariest Stock: Overstock.com

Looking for a scary Halloween theme this year? How about Overstock.com's (NYSE: OSTK  ) price-to-earnings ratio?

Oh, wait, it doesn't have one.

That's because the company hasn't earned an annual profit since the beginning of its existence in 1999. Nothing scares me more this Halloween than Overstock's valuation. Investors who have recently profited from the online retailer's 125% run-up this year might consider pocketing their winnings on this overbought stock and running before things turn sour.

To me, Overstock is just another moatless Internet company that reminds me of the bad old days of the tech boom. The business model is not unique, and the site's prices are no better than what you can find at discount retailers such as Ross Stores (Nasdaq: ROSS  ) or TJX's (NYSE: TJX  ) T.J. Maxx. In addition, its closest competitors, eBay (Nasdaq: EBAY  ) and Amazon.com (Nasdaq: AMZN  ) , boast far more popular brand names.

In fact, I've never even been to Overstock.com, except to read its financials. And I'm apparently not alone. Alexa.com provides the gloomy evidence: eBay ranks No. 20 in traffic rank, and Amazon isn't too far behind at No. 32, while Overstock is ranked No. 1,343.

The financials are even more frightening. Over the years, Patrick Byrne has, well, burned through cash as if he were throwing it on an autumn bonfire. And while it appears that some improvement could be on the way, remember that looks can be deceiving. The company recently celebrated a quarter with positive EBITDA, and the cash-flow situation looks to be progressing -- but these accomplishments were made possible only by cutting back on capital expenditures.

6/30/06

9/30/06

12/31/06

3/31/07

6/30/07

9/30/07

Cash From Operations

($39.4)

($18.7)

($25.7)

($11.4)

$9.7

$6.2

Capital Expenditures

$32.3

$27.9

$23.4

$17.1

$13.5

$6.0

Free Cash Flow

($71.7)

($46.6)

($49.1)

($28.5)

($3.8)

$0.2

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

Slashing capital expenditures in half may sound impressive, but how does the company expect to continue to grow and compete against its gigantic competitors? It just doesn't seem wise to cut marketing expenses by 50% this past quarter when revenue fell 5.8% over the past 12 months. Sure, these strategies provide short-term relief in the financials, but I just don't think they will generate the 20% annual growth that analysts expect over the next five years.

Economic indicators have been dismal lately in response to a bursting housing bubble and a credit crunch. Consumers are in a pinch, and retailers are experiencing the side effects of a slowing economy. Times like these make it difficult for even the most successful retailers to survive. So I can't fathom how a debt-laden enterprise posting operating losses can endure any economic downturn.

Overstock's surging price has been driven solely from irrational exuberance. There are simply too few fundamentals to support a company that's selling at 5,510 times its trailing 12 months of free cash flow. Even if the company succeeds in posting a profit next year, its forward P/E is 444.4.

Sometimes, great companies become overvalued from the momentum of a rising market. A lofty price alone, however, doesn't make a compelling investment thesis.

A weak business model, astronomical valuation, and poor financial management are all reasons to follow the CAPS community on this one. Our CAPS players have cumulatively given the stock a mere one out of five possible stars. Don't haunt your portfolio with Overstock.

I recently shorted Overstock in CAPS and think it's the scariest stock in the world. Do you agree? If so, come on over to CAPS and mark the company as "underperform."

Want to know what other companies give us the frights? You can view the rest of our hair-raising stocks here.


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