Although Zillow (currently trading at $71.68 per share) has gained 20.6% over the last six months, it has trailed the S&P 500’s 30.6% return during that period. This might have investors contemplating their next move.
Is there a buying opportunity in Zillow, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free for active Edge members.
Why Do We Think Zillow Will Underperform?
We're swiping left on Zillow for now. Here are three reasons why ZG doesn't excite us and a stock we'd rather own.
1. Revenue Spiraling Downwards
A company’s long-term performance is an indicator of its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Over the last five years, Zillow’s demand was weak and its revenue declined by 7.8% per year. This was below our standards and signals it’s a low quality business.
2. Operating Losses Sound the Alarms
Operating margin is an important measure of profitability as it shows the portion of revenue left after accounting for all core expenses – everything from the cost of goods sold to advertising and wages. It’s also useful for comparing profitability across companies with different levels of debt and tax rates because it excludes interest and taxes.
Zillow’s operating margin has been trending up over the last 12 months, but it still averaged negative 8.4% over the last two years. This is due to its large expense base and inefficient cost structure.
3. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Zillow’s ROIC has unfortunately decreased. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
We cheer for all companies serving everyday consumers, but in the case of Zillow, we’ll be cheering from the sidelines. With its shares trailing the market in recent months, the stock trades at 38× forward P/E (or $71.68 per share). This valuation tells us a lot of optimism is priced in - we think there are better stocks to buy right now. We’d recommend looking at our favorite semiconductor picks and shovels play.
Stocks We Like More Than Zillow
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