Zillow (NASDAQ:Z) may be a go-to tool for house hunters, but the stock has generated anything but impressive results for investors recently.
Down 21.8% YTD, shares of Z have cratered at a time when the S&P 500 is up by 7.5%. What’s causing Zillow shares to fall and does the loss of value present a buying opportunity for investors looking for deals in today’s high-flying market?
Why Did Zillow Stock Go Down?
Zillow stock fell following a recent court ruling and subsequent legal case brought against the National Association of Realtors and other brokers.
The legal proceedings challenged the common practice of home sellers paying realtor commissions for buyers. With changes being made to how realtor fees are charged, experts expect commission reductions of up to 50%.
While Zillow isn’t directly affected by this ruling, it still has the potential to drive down the company’s revenues. The platform makes the majority of its money from realtor advertising dollars.
With commissions expected to drop so much in the wake of the recent ruling, these professionals are likely to spend much less on advertising, a phenomenon that in turn could disproportionately impact Zillow.
Though Zillow has seen large losses, it’s worth noticing that other real estate companies have also experienced declining share prices in the decision’s wake.
Redfin, a broker and mortgage origination company, has lost over 30% of its value in the last three months. RE/MAX Holdings, meanwhile, has lost over 28% during the same period.
Where Does Zillow Stand on Value?
Depending on your point of view, there are arguments to be made that Zillow is either overvalued or undervalued.
On paper, the stock still looks fairly expensive. Z shares trade at 5.4x revenues, a multiple that wouldn’t be terrible if the company wasn’t quickly losing money.
Over the trailing 12-month period, though, Zillow has lost $158 million and reported a net margin of -8.1%. Though Zillow has produced sporadic profitable quarters, its ability to generate positive net income has been very inconsistent.
On the other side of the coin, bullish analysts point out that Zillow was not a named party in the NAR suit, meaning that the impact on the company will be indirect. As such, the significant pullback in share prices that has occurred this year could create a buying opportunity, provided Zillow’s fundamentals remain stable.
The latter view largely tracks with analyst price forecasts for Zillow. Z stock has a median 12-month target price of $61.50, about 37% above the current market price of $44.85.
Investors should note, though, that the NAR only settled the lawsuit against it in mid-March. As such, some analyst forecasts may not yet have been adjusted to price in the upcoming changes in commissions.
Institutional ownership of Zillow remains quite high at over 70%, a fact that indicates strong Wall Street support for the stock’s value proposition.
That view, however, may be overshadowed by the fact that institutions have sold nearly $400 million more in Z than they bought over the past year.
Selling activity was especially strong in Q4, when institutional investors sold over $600 million worth of the stock and bought just over $190 million.
Zillow’s Pitfalls
Another problem for Zillow is its modest rate of revenue growth. In Q4, revenues rose by 9% year-over-year. While far from a poor showing, this single-digit growth rate may be a bit low for an unprofitable company that trades at a fairly high multiple to its sales. Revenue was even worse for the full year of 2023, coming in at 1% lower than 2022.
Zillow’s growth plans will likely also give investors pause. The company is increasingly focusing on mortgage leads and rental services to generate growth.
While potentially lucrative, Zillow will have to prove that it has the expertise to pull this transition off. Longtime watchers of the stock will remember the company’s direct investment in properties, which came to an abrupt end in 2021.
As Zillow attempts to diversify, management will have to convince investors that its current efforts will be more sustainable.
The real estate market may also slow in 2024 as a result of higher interest rates that are driven by sustained inflation, and in turn create poor conditions for homebuyers.
Until the Federal Reserve begins to lower its rate floor, Zillow and other companies like it could see downward pressure on revenues.
Is Zillow a Buy?
Despite its challenges, Zillow still has plenty to recommend it. First and foremost is the platform’s massive name recognition and widespread use. About 67%of US home buyers use Zillow or one of its platforms during their real estate search. Zillow is also the single largest real estate website in the US.
Zillow is in a prime position to benefit when interest rates eventually come back down. Though inflationary pressures will likely see rates remain higher for longer than expected this year, the Federal Reserve still appears determined to begin loosening interest rates to prevent a slowdown in the US economy.
When interest rates do come down, one of the results will likely be a spike in real estate demand that should benefit Zillow by increasing realtors’ willingness to invest in advertising.
Even with these strengths factored in, however, Zillow appears to be a stock that’s better to hold or watch than to actively buy.
Until it becomes clear how much impact lower commissions in the real estate industry will have on the company’s advertising revenues, investors will have difficulty forming a clear picture of what Zillow’s future revenue growth will look like. Given that the company is still far from profitability, it also can’t justify its price with reliable future cash flows.
That isn’t to say, however, that Zillow isn’t worth watching. If revenues don’t take an appreciable hit in the upcoming quarters, the stock could still present an interesting long-term opportunity.
Zillow’s competitive moat and potential to benefit from future interest rate cuts both make it attractive, but investors will likely need more certainty around revenues before deciding to buy shares of Z.
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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.
