The Overstock Rocket

"The reader now knows everything I know."

It's easy to root for the good guys -- especially when the stock is on fire. Shares of Overstock.com (NASDAQ:OSTK) are up 18% to an all-time high over $55 following the online discount retailer's third-quarter report. While a good chunk of the action is surely attributable to mass short covering, the stock has been just about doubled off its August lows. And since Overstock President Patrick Byrne's fourth quarter letter made TheStreet.com's (NASDAQ:TSCM) "five dumbest things heard on Wall Street" list this past January (see The Overstock Letter), the stock has tripled.

We rave about these shareholder letters every quarter because they aspire to treat shareholders as fellow owners and keep the business owners informed. Byrne explains it as he sees it so that "the reader knows everything he knows," leaving the reader to agree or disagree.

Here's how I read it:

In the third quarter, Overstock saw gross bookings climb 87% to $114.4 million, with business to the core consumer alone jumping 119% to $110.5 million. Gross profits more than tripled to $13.7 million, as gross margins edged up 200 basis points to 13.3%. The end result was a net loss of $3 million, or $0.16 per share, better than last year's loss of $3.7 million.

Meanwhile, the average customer acquisition cost climbed to $18.30.

During the quarter, Overstock added two new business lines. In the shareholder letter, Byrne described Club O Gold as a "B2B exchange model," where small businesses can purchase supplies at a discount to help gain cost advantages over their competitors; the membership fee is $99. The other addition was Overstock.com Auctions, aimed at chipping away at eBay (NASDAQ:EBAY). That business got some quick publicity: Anyone who has used Viacom's (NYSE:VIA) Sportsline.com website in the past few days knows that Barry Bonds' 700th home run ball was auctioned off on Overstock's auctions site.

As Byrne has explained before, future profits and margin expansion will come from accelerating sales growth over fixed administrative costs. However, the addition of two new lines during Q3 -- Club O Gold and the auction business -- would skew the margin picture somewhat, as Club O Gold is a low-margin business, and the auction business carries high margins. That said, Byrne re-emphasized that the end focus should continue to be on absolute gross-profit dollars.

In refuting reports, Byrne reiterated that the company would continue to plan around 100% revenue growth, meaning that the company would be prepared to do $500 million in business this year, $1 billion next year, and $2 billion the year after. For the record, Byrne insisted that he doesn't actually know "how fast we are going to grow," and that "it is better to overestimate than underestimate."

Reading through the letter, it's clear that Byrne believes there are further costs to be wrung out. He explains how he looks at profitability vs. growth, why he thinks the auction business will be successful, and relates that the company is prepared ahead of the holiday onslaught for the first time since the website's launch in October 1999.

There's a lot of information here.

Last spring, we thought Patrick Byrne had the pedigree (see "Overstock's Buffet Style:) before Bill Mann chose Overstock in Motley Fool Select, the precursor to the Motley Fool Hidden Gems newsletter. But now, I think Overstock is demonstrating that it is a viable player amidst the likes of Motley Fool Stock Advisor recs Amazon.com (NASDAQ:AMZN), Best Buy (NYSE:BBY), and eBay.

I suggest that any investor read through Byrne's shareholder letters. If you disagree with his thinking, move on. If you can identify with his reasoning, then there's plenty of Fool coverage. Check out the Fool's four-part interview with Patrick Byrne:

When you're done with that, check out:

Fool contributor Jeff Hwang owns shares of Overstock.com and eBay.

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