Growth stocks: MercadoLibre shares fall despite record revenues

Growth stocks require patience, and MercadoLibre (NASDAQ: MELI) is currently testing exactly how much its shareholders have. Sales are growing impressively, but profits are going the wrong way.

The company’s latest results reveal record revenues. But with margins under pressure from ongoing investments, where does the return come from for investors?

Three businesses, one flywheel

MercadoLibre is an online marketplace operating in 18 countries across Latin America. But it’s much more than just this. 

It also has a distribution network, a payments platform, and a rapidly expanding lending business. All of these work together to create a mutually reinforcing ecosystem.

All of this sounds good and it gives the firm a strong competitive position. The problem is that it’s expensive to build an operation on all of these fronts simultaneously.

The latest results illustrate this pretty well:

It’s impossible to ignore 50% revenue growth, regardless of what the business is. But it’s also hard to dismiss operating income falling while this happens.

The big question for investors is why. And there are two competing stories.

Why are margins contracting?

Investing into its network allows MercadoLibre to keep its prices down to customers. That makes it more attractive and strengthens its long-term competitive position. 

The cost of this is short-term profitability and that’s a trade the company is making. But the question is whether it’s doing this because it wants to, or because it has to.

One idea is that MercadoLibre is proactively looking to stay at the front. Investing in lower prices makes it harder for competitors to gain traction.

Another is that the company’s hand is being forced by rivals. With Amazon, Shoppee, and Temu all looking to expand, the firm can’t get away with its current margins.

The first situation is positive for investors, the second is negative. The issue for investors is which one reflects the underlying reality.

What to do?

I’m a big fan of companies that make investments to maintain lower costs and better customer value. But this doesn’t always work out well for shareholders.

CostCo is an example of a company that does this extremely well and investors have benefited as a result. By contrast, things haven’t worked out so well for Wise – at least, not yet.

Which one does MercadoLibre ultimately resemble? I think that’s a difficult question to answer from an entirely different continent. 

Fighting off smaller competitors is one thing, defending against Amazon is another. That makes me wary of the situation today.

The stock is trading at some unusually low valuation multiples right now. But without a clear sense of the outlook for margins, I find it difficult to buy.

Watch carefully

Charlie Huggins – a former fund manager at Wealth Club – distinguishes between companies investing because they want to and those spending because they have to. And I think it’s hugely important.

Exactly which category MercadoLibre falls into, I’m not entirely sure. The entire truth might be that there’s a bit of both involved.

I’m leaving this as one to keep an eye on, rather than to go chasing. But I’ll be watching closely to see how the competitive situation develops.

Should you invest £5,000 in MercadoLibre right now?

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And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if MercadoLibre made the list?

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Stephen Wright owns shares in Amazon.

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