Online retailer eBay (EBAY) went on an incredible run from March through July. The stock gained over 135% from its low to its July high. The company reported earnings on July 28 and the stock slipped a little after the earnings report.
The earnings weren’t bad. In fact the company surpassed both the EPS estimate and the revenue estimate. What appears to have happened is that the expectations from investors were simply too great and the stock was bound to take a breather from its massive rally.
This happens from time to time and when it does it can provide a great opportunity for investors that exercise patience.
Right not it looks like the pullback has run its course and the stock has hit support at its 50-day moving average. There is also a trend line that connects the lows from the spring with the recent low, and that is providing a second layer of support for the stock to use as a springboard.
We see how the low from March connects with the low from early April to form the trend line. The recent pullback caused the stock to hit the trend line and the 50-day is almost right on top of it.
The daily stochastic indicators fell and were hovering just above oversold territory before making a bullish crossover on August 12. The combination of the bullish stochastics crossover along with the support from the trend line and 50-day should help propel eBay higher in the coming weeks.
Strong fundamentals
While the chart is what initially got my attention, eBay’s fundamental indicators help explain why the stock has rallied so much. The company saw earnings grow by 64% in the most recent quarter while revenue jumped 18%.
Those figures are accelerating compared to the last three years. The company has averaged EPS growth of 19% per year over the last three years while revenue has increased by an average of 3%.
eBay also boasts strong management efficiency measurements with a return on equity of 52.2% and a profit margin of 26%. Even after the big rally, the valuations for eBay are very modest with a trailing P/E ratio of 19.8 and a forward P/E of 15.3.
Yet another positive for eBay is the sentiment from analysts. There are 35 analysts covering the stock and only 12 have it rated as a “buy.”
The other 23 have the stock rated as a “hold.” From a contrarian perspective, this is a good thing. It leaves plenty of room for upgrades.
As for how to benefit from the next upward cycle, I think the best way to play it is with the October 55-strike calls. The stock is currently trading at $56.65 and the calls are trading at $4.15.
I think the stock can rally between 10% and 15% over the next four weeks or so and that would put the stock between $62.32 and $65.15. That would mean the options would be worth anywhere from $7.32 to $10.15.
Such a move would give the option traders a gain between 75% and 145%.
