Overstock.com (NASDAQ:OSTK) stock is proof of why investors shouldn’t be scared to chase rallies, so long as those rallies are well-founded and the valuation leaves room for further upside. Back in early May, OSTK stock flew on my screen as one of the hottest e-commerce stocks in the market.

At the time, the company was undergoing a resurgence thanks to the Covid-19 pandemic pushing home decor shopping into the online channel, and OSTK stock was coming back from the dead.

Shares had rallied more than 500% from $2.50 lows in March, to $16 in early May.

I said chase the rally, calling Overstock.com one of the best turnaround stories in the market. The fundamentals were rock solid. The momentum was undeniable. And the valuation lefts tons of room for further upside.

And guess what?

Overstock.com has flown higher ever since. By another 650% to $120 today.

Unfortunately, though, all good things must come to an end, including this rally in Overstock.com. The fundamentals remain rock solid. The momentum is still undeniable. But the valuation is maxed out, and that means it’s profit-taking time.

Here’s a deeper look.

OSTK Stock Has a Great Story

The Overstock.com story is about as good as it gets in terms of a turnaround story in the market today.

Buying furniture online was niche prior to 2020. Only about 13% of furniture sales happened in the online channel, versus 30%-plus digital penetration for apparel sales and 40%-plus digital penetration for consumer electronics sales.

Then Covid-19 hit. Consumers looking to buy new furniture and home decor were forced into the online channel. E-commerce penetration in this under-penetrated category soared. And it has stayed high, even as physical stores have reopened because consumers are liking what they found in the e-commerce channel.

That is, technological improvements over the past few years — such as augmented reality features like “Try in Room”, lightening-fast logistics, robust review systems, data-driven product curation, etc — have made the online home decor shopping experience as robust as the physical one, meaning consumers have little need to go back to shopping for furniture in stores.

To that end, Covid-19 has permanently accelerated e-commerce adoption in the furniture retail category.

This has essentially saved Overstock.com, a company that has been withering away and dying for several years until, in late 2019, a new management team introduced a wide array of sweeping changes. Those changes have coupled with reinvigorated growth in the online home decor market to spark enormous growth in Overstock.com in 2020.

This big growth will persist for the next several years, driven by: 1) a continued uptick in online home decor sales, 2) Overstock.com leveraging platform improvements to drive market share expansion from a depressed base, and 3) the company’s new but burgeoning blockchain initiatives.

Net net, OSTK stock is supported by one amazing turnaround story.

Great Momentum

In addition to having a great turnaround story, Overstock.com also has robust operational momentum today.

The company just reported second-quarter numbers. They were fabulous.

Retail revenues rose 109% year-over-year in the quarter. New customers rose 205%. Gross margins expanded 347 basis points to a record-high 23.2%. The opex rate fell 496 basis points to 17.2%. Adjusted EBITDA margins came in at 6.9%, versus 0.4% in the year ago quarter. Adjusted EBITDA dollars rose from less than $2 million a year ago, to $53 million this quarter.

Across the board, you had huge growth.

And this big growth likely won’t slow down anytime soon.

According to JPMorgan’s credit card data, digital retail sales continue to rise at a ~8% pace, the same pace at which they’ve been rising for the past several months. Against that backdrop, it’s fairly likely that Overstock.com is sustaining triple-digit revenue growth into July and August.

Plus, consumers are likely to avoid crowds this holiday season, and therefore, migrate a bunch of their holiday shopping into the online channel, implying that Overstock.com could have a big fourth quarter, too.

All in all, it looks like Overstock.com is well positioned to report huge growth for the next two quarters, at least.

Fully Priced Overstock.com Stock

Despite being supported by a great story and having great momentum at the current moment, OSTK stock isn’t a buy here for one simple reason: Valuation. In short, OSTK stock is just overvalued.

And I say that despite making some fairly aggressive assumptions about the company’s long-term growth prospects. Specifically, I’m modeling for:

• E-commerce penetration in the home goods market to rise towards 35% by 2030, from 13% today, and largely consistent with where apparel e-commerce penetration sat in 2019.
• Overstock.com expands its market share in the home goods e-commerce market from ~3.7% last year, to 5% by 2030, powering 15%-plus compounded annual revenue growth.
• Gross margins rise to north of 25%.
• Economies of scale drive adjusted EBITDA margins to just shy of 10%.
• Earnings per share grow from a projected 9 cents per share this year to $9 by 2030.

Those are aggressive and optimistic long-term growth assumptions.

Still, they don’t support an OSTK stock price today of $120.

Based on a 20-times forward multiple, $9 in 2030 earnings per share implies a 2029 price target for Overstock.com of $180. Discounted back by 8.5% per year, that implies a 2020 price target of below $90.

Thus, at $120, OSTK stock is simply too richly valued to be worth chasing… despite the great story and robust momentum.

Bottom Line on OSTK Stock

Overstock.com stock has long been one of my favorite turnaround stocks to buy.

But this huge rally has run its course.

The valuation on OSTK stock is now full. Too full. So while the company may continue to fire on all cylinders over the next few months, the stock could fall flat, thanks to valuation friction.

To that end, I say it’s time to profit take.