The following segment is taken from this funding letter.
Below is a historical case study of Mercado Libre during the last two major market declines (in 2001 and 2008, respectively). Mercado Libre was a young company, less than 10 years old, with high double-digit annual growth, and was just beginning to mark its industry with single-digit market shares in its addressable markets.
Free market (NASDAQ: MELI)
Mercado Libre, the e-commerce leader in Latin America, is another example of this dynamic. Mercado had just gone public in August 2007, and the stock immediately skyrocketed in the following months. At its peak in December 2007, the company was valued at ~$3.5 billion despite earning just $85 million that year (~41x price/sales) and revenue growth of 64% a/a.
But unlike Amazon’s situation, Mercado has been very profitable since its IPO. Operating margins were around 25% and gross margins around 85%. Despite its highly profitable business model, its shares fell from those lofty valuations throughout the 2008 financial crisis.
Mercado Libre Stock Chart
August 2007 – December 2011
The stock price reached ~$8 in November 2008, which equates to a valuation of around $360 million. Revenues increased to $137M in 2008 (61% YoY growth) and operating income increased by a similar amount (73% YoY growth, 27% operating margins) for reach $37.5 million. This equates to ~2.6x Price/Sales and ~10x operating profit at the bottom. The company continued to execute and its fundamental trajectories remained intact, despite the lackluster market sentiment.
Notably, the stock price did not stay at these levels for long and doubled soon after. By the end of 2008 it had hit $17 a share as market sentiment for many growth companies turned around towards the end of the year (and about 4 months before the broader indexes turned around ).
The company experienced slower growth coming out of the recession, increasing revenues by 26% and 25% in 2009 and 2010, while operating profits grew 49% and 33% yoy, respectively.
The stock price rebounded rapidly over the next year and reached $50 by the end of 2009 (a 525% return from the bottom and a 194% return from the end of 2008) . This equates to a valuation of 9x Price/Sales and 27x operating profit.
In 2011, revenues reached $299M (38% year-over-year growth) with operating margins of 33%. The stock was trading at 12x P/S or ~37x operating earnings, and the price had rebounded ~10x from the low in the space of 3 years.
This is just one selected example, but investors can go back to past market crises to find similar dynamics among other stocks. All this to illustrate that what really matters for whether a stock is recovering after a bear market is:
- if its fundamentals continue to grow throughout the period, and
- whether the business is able to prove that it can be profitable.
If the company’s performance is permanently impaired, you can expect its share price to be as well. But if the company is able to grow during the bear market/recession or optimally emerge from it even stronger, you tend to see the stock price bounce back quickly (usually several times from the lows) within 1-2 years after set. market sentiment improves and panic selling subsides. If we have confidence in the fundamentals of our businesses and valuations are reasonable, stock prices will reflect this in due course.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.