Carsales upgraded to Buy

The big banks have been getting the headlines in the latest market rout, but internet classifieds stocks have suffered larger falls, with REA Group dropping 13% in the past few weeks, Seek down 11% and Carsales down 16%. Less mature stocks have suffered even more, with iCar Asia, in which Carsales has a 23% stake, down 35% from its July peak, and iProperty Group, in which REA recently invested (see REA buys stake in iProperty Group), down 32%.

A small part of Carsales' fall (slightly less than 2%) can be explained by the stock going ex its 17.4 cent final dividend last week. The 2015 consensus earnings forecast has also edged down from 47 cents to 46 cents following the company's 2014 result. But the bigger effect is probably just that the market has been looking for things to sell and these stocks have made good targets due to their elevated price-earnings ratios (which now stands at about 21 for Carsales for 2015).

As we've mentioned before, though, the PER doesn't tell the whole story for these stocks, because they require very little capital, allowing almost all their earnings to come through as free cash. This puts Carsales, for example, on a free cash flow yield of more than 4%. That looks attractive given its long-term growth prospects.

The stock is down 12% since Carsales: Result 2014 on 14 Aug (Hold – $10.97), putting it well below our $10 buy price and we're upgrading to BUY.

Note: Our model Growth and Income portfolios hold shares in Carsales.