Why MercadoLibre shares are cheaper than they look

MercadoLibre (MELI -1.05%) is often compared to Amazon for its strong success in the e-commerce market. Its focus on Latin America — with its emerging markets that have attractive prospects — has made it an intriguing growth stock to own.

And over the past five years, the stock’s 150% return has outpaced that of Amazon, whose shares have gained about 97% over the same period.

However, some investors may be increasingly concerned that MercadoLibre has become too expensive. It trades at more than 70 times earnings, which may be a difficult valuation to swallow, especially as concerns grow that the stock market may have overheated this year due to S&P500 continuing to break new records.

Why MercadoLibre Stock Looks Expensive

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

In other cases, a company may be growing rapidly and generating strong market growth, but its margins are not high enough to prevent its earnings multiple from increasing too quickly.

MercadoLibre falls into the latter category. While the top line has moved upwards, and with it the share price, the bottom line has been growing at a slower pace.

MELI revenues (quarterly); data according to YCharts.

Over the last 12 months, the company has achieved an average profit margin of just over 7%. That’s a decent margin, but the company is working to increase it. If successful, it would mean more of each new revenue dollar would go to net income.

Investors should not overlook the promising growth potential

For growth investors, an important metric to consider is the price-to-earnings-to-growth (PEG) ratio. This takes into account the P/E ratio along with how much analysts expect the company to grow in the future (usually over the next five years).

Given a PEG ratio of less than 1.5, MercadoLibre stock may seem slightly more expensive, but not by much. Typically, growth investors view a PEG of 1.0 as the dividing line between good growth stocks and expensive ones. The lower the PEG, the better the buy. While MercadoLibre exceeds this threshold, it is not significantly higher.

In the very long term, the company may have even more room to increase its value. It is a growing business present in 18 countries and with over 100 million active users.

Fintech is another development opportunity for MercadoLibre. It operates Mercado Pago, an online payment platform through which merchants can accept bank and credit card payments.

Is it worth buying MercadoLibre shares?

MercadoLibre may be a good option for growth investors to consider today. While its price may seem high right now, it’s important to always consider where your business could be not in a year or two, but also in five or ten years. Based on this potential, it looks like MercadoLibre could be a cheap buy.

The company has established itself as a big name in Latin America, and as these markets expand, the gains could be significant for investors who are patient and stay the course. Stocks can also be a great way to diversify your portfolio and gain exposure to promising emerging 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 has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon and MercadoLibre. The Motley Fool has a disclosure policy.