Why I'm not keen on Carsales.Com Ltd at today's share price

Carsales.Com Ltd (ASX:CAR) is a good business, but investors need to be wary of overpaying.

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I like Carsales.Com Ltd (ASX: CAR) a lot. It's got a good business model, a good financial position, it's innovative, founder-led, and has a few international growth opportunities it could benefit from over the next decade or so.

However, I sold my shares a few months ago, primarily because I was concerned about the company's valuation. At $13 a share, Carsales was priced at around 30 times its earnings, equivalent to CSL Limited (ASX: CSL), but Carsales' product – advertising – lacks the life-changing, patented, and government-reimbursable attributes of CSL's products.

Carsales also has less of an ability to create vital products from scratch, whereas CSL has dozens of them in development. There are a relatively small number of medical researchers with the funding and expertise of CSL, but plenty of companies with the advertising and online expertise to compete with Carsales. Even though they are completely different businesses, I don't think it is correct for Carsales to be valued the same as CSL – especially since they are growing at about the same rate.

At today's prices, Carsales is cheaper than CSL, but I still reckon investors need to have a think about its valuation before making a purchase. For the past two years, Carsales' profits have grown by less than 10% per annum, and appear likely to grow at the same rate – or slower – this year. It's priced more like a small-cap growth company than the mature business that it is.

Management is expanding into a number of parallel businesses with the goal of reinforcing Carsales' all-important network effects. This effect is where more buyers on a platform attract more sellers, which in turn attracts more buyers. I have no qualms with the job that management is doing, but I think that one negative event, such as a decision to exit a new business because it wasn't working or wasn't sufficiently profitable, would quickly knock the gloss off Carsales' shares – even if the financial impact on the business wasn't that big.

Foolish takeaway

We've seen a repricing happen with other 'growth' companies recently, and it's not a great stretch of the imagination to see it happening to other businesses like Carsales. I don't think there's any immediate need to dump Carsales – as I mentioned, it has a lot going for it. I do think that investors buying it today need to either take a long-term view, or have a good think about what price they'd be willing to pay for shares today.

Motley Fool contributor Sean O'Neill doesn't own shares of any company mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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