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Why MercadoLibre shares are cheaper than they look

The Latin American e-commerce company has great growth potential and could therefore become a bargain in the coming years.

MercadoLibre (MELI -1.05%) is often compared with Amazon for its great success in the e-commerce market. The focus on Latin America – with its developing markets offering attractive prospects – has made the company an interesting growth stock.

And over the past five years, the stock has returned 150%, outperforming Amazon, whose value has risen by about 97% over the same period.

But some investors are increasingly concerned that MercadoLibre has become too expensive. The company trades at more than 70 times earnings, which can be a difficult valuation to digest, especially as fears grow that the stock market may have overheated this year. S&P500 and continues to set new records.

Why MercadoLibre shares seem expensive

The problem with looking at the price-to-earnings (P/E) ratio is that it only tells you how a stock is valued based on its earnings over the last four quarters. If a company had a bad quarter or had unexpected expenses, that would impact those numbers.

In other cases, a company may be growing quickly and generating a lot of optimism in the markets, but its margins are not high enough to prevent the earnings multiple from rising too quickly.

MercadoLibre falls into the latter category. While sales and thus the share price are skyrocketing, profits have increased more slowly.

MELI sales chart (quarterly)

MELI revenue (quarterly); data from YCharts.

Over the last twelve months, the company achieved an average profit margin of just over 7%. That’s a decent margin, but the company is working to increase it even further. If it can do that, every additional dollar of sales will have a positive impact on the bottom line.

Investors should not overlook the promising growth potential

For growth investors, the price-to-earnings-to-growth (PEG) ratio is an important metric. It considers the P/E ratio along with analysts’ forecast for the company’s future growth (usually the next five years).

And based on a PEG ratio of less than 1.5, MercadoLibre stock might look a little expensive, but not by much. Typically, growth investors consider a PEG of 1.0 to be the line between a good growth stock and an expensive one. The lower the PEG, the better a buy. MercadoLibre is above that threshold, but not significantly higher.

In the long term, the company could become even more valuable. It is a growing company with a presence in 18 countries and over 100 million active users.

Fintech is another growth opportunity for MercadoLibre. The company operates Mercado Pago, an online payments platform that allows merchants to accept bank and credit card payments.

Should you buy MercadoLibre shares?

MercadoLibre can be a good option for growth investors today. While the price may seem high right now, it’s important to always consider where the company could be not just in a year or two, but in five or ten. And based on that potential, MercadoLibre looks like it could be a cheap buy.

The company has established itself as a major brand in Latin America, and as these markets gain size, this could pay off significantly for investors who are patient and stay the course. The stock can also be a great way to diversify your portfolio and gain exposure to some promising developing markets.

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. David Jagielski does not own any of the stocks mentioned. The Motley Fool owns positions in and recommends Amazon and MercadoLibre. The Motley Fool has a disclosure policy.

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