If I told you about a small-cap online retailer that grew revenues 3% in the latest quarter after a 13% decline a year earlier, you’d be curious. Who is this company and why such a turnaround?

If I also told you that this online retailer had a 6% increase in orders during the quarter and a 3% increase in average order size — you’d be like, where do I sign up?

Of course, I’m talking about Overstock.com Inc (NASDAQ:OSTK), the online retailer that sells stuff cheap but also has a hankering for blockchain investments.

Who says the conglomerate is dead?

Anyway, since the beginning of the year, Overstock has lost 42% of its value and now trades in the mid- to high-$30s.

Speculative investors see a decent quarter from Overstock’s primary business and think there could be a profitable trade to be made.

Don’t. There isn’t. Here’s why.   

Overstock Will Never Make Enough Money

Ok, never is a really long time, and what is it they say? Never say never. I suppose anything is possible: I could become a billionaire, but we all know, including myself, that ain’t happening.

Overstock’s retail business — the only one that counts — had a pre-tax loss of $33.6 million in the first quarter on $445.3 million in revenue. In first quarter 2017, its retail business contributed $49.2 million to Overstock’s profit before technology, general and administrative, and interest expense, a contribution margin of 11.5%.

In this year’s first quarter, the retail contribution was $18.5 million, a contribution margin of just 4.2%.

CEO Patrick Byrne would say the decline is a result of the company’s shift to a growth model that requires greater sales and marketing expenses.

“This significant increase in sales and marketing expenses was primarily due to our recently adopted retail growth strategy to more aggressively pursue increased revenue and new customers,” stated Overstock’s Q1 2018 press release.

At the same time, it’s altering its business plan for more growth, less profits; it’s having a difficult time adapting to the 2017 changes to the Google algorithm.

I once worked for a Canadian internet company that got put out of business because of algorithm changes by the search engine champion. It’s a bigger deal than many might think.

Overstock Needs Higher Gross Margin

The problem that I see with Byrne’s plan is that Overstock’s gross margin must be a lot higher than where it is at the moment if it ever wants to make money and grow at the same time.

In the first quarter, the retail business’s gross margin was 21.0%, 100 basis points higher than a year earlier. As far as I know, that’s the highest its gross margin has ever been.

Unfortunately, to get that 100 basis-point boost, it spent an additional $36.6 million on sales and marketing to achieve that increase. For every additional dollar of gross profit it received in the quarter, Overstock spent more than five times that on sales and marketing.

It’s spending almost 17% of its revenue on sales and marketing. By comparison, Wayfair Inc (NYSE:W), a stock that’s also got issues, spent 11.5% of revenue on advertising in its latest quarter; its gross margins were 23.1%. It too has a problem making money.

Bottom Line on Overstock

Back on January 22, I said the following about Overstock:

“If Overstock was simply an online retailer, there is no way I’d recommend its stock — the same piece of advice I recently gave about Wayfair — when you can buy Amazon.com, Inc. (NASDAQ:AMZN), a business that generates almost $10 billion in free cash flow (FCF) annually,” I wrote. “Investing is all about probability.”

It’s dropped from the high $70s since. At $37 or 50% off, it’s still not worth buying.

As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.