For years, satirical late-night TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.
What Trulia does
Trulia is a company that, through its website and mobile software, allows real estate agents, through premium and free services, to list their properties for sale. It also sells digital marketing space and provides tools for consumers to research schools, crime rates, neighborhood values, and other pertinent aspects to purchasing or renting a home.
In Trulia's most recent quarter, the company reported a near-doubling in revenue to $24 million, with total traffic rising 52% to 31.4 million users. Perhaps most impressive was the company's mobile traffic, which soared 122% to 11.4 million monthly unique users. Overall net loss for the quarter was halved to just $2 million from $4.2 million in the year-ago period.
There are two primary risk factors that a company like Trulia has to contend with: the risk of increased competition and real estate risk.
The first risk is clear as day. In addition to Trulia, Zillow (NASDAQ: ZG ) and Move (NASDAQ: MOVE ) have found success over the past couple of quarters as the housing market has found a floor and inventory levels have dropped to multi-year lows. Zillow, for example, recently kicked off its first national TV ad campaign meant to boost its image and public awareness of the brand. With $179 million in cash and web traffic up 63% in its most recent quarter, there's a lot of reason to believe it'll give Trulia a run for its money. Similarly, Move witnessed its mobile app views jump by more than 100% from the previous year despite a tame 3% growth in website traffic. Simply put, if Trulia can't differentiate itself from Zillow and Move.com, it could be difficult to grow its top and bottom lines.
The other factor that'll weigh on Trulia's success or failure is whether or not the homebuilding market is cooperating. Luckily for Trulia, we're seeing continued signs of success across the board with the National Association of Home Builders Housing Market Index coming in at a seven-year high yesterday. KB Home (NYSE: KBH ) , for instance, which focuses on middle-and-upper income first-time and trade-up buyers, saw revenue increase 59% in the first-quarter from the year-ago period as its average selling price vaulted higher by 24%. Even struggling homebuilder Beazer Homes (NYSE: BZH ) , which tends to market toward lower- to middle-income first-time buyers and retired persons, saw its revenue leap 51% as average selling prices added nearly 13% in the second quarter. The point is that low inventory levels are leading to higher home prices and renewed interest in owning a home.
After carefully reviewing the prospects for Trulia, I've decided to go against the current grain and make a CAPScall of underperform on the company.
Admittedly, I thought twice about betting against Trulia's rapid mobile traffic growth and the current strength of the homebuilding sector. However, I see multiple factors that could easily derail Trulia and the sector.
The biggest and most forthcoming concern relates to when and how the Federal Reserve will pare back its $85 billion in monthly bond buying. These purchases, which consist of mortgage-backed securities and long-term U.S. Treasuries, have been largely responsible for keeping long-term lending rates low and stabilizing the housing market. When the Fed begins to pare back these purchases, we could see a pretty sizable bump higher in interest rates. I'm not sure if you've paid attention to how easily an interest rate bump affects mortgage applications, but any significant move higher over the past two years has been met with a sharp decline in refinance and new purchase loan applications. I firmly believe the Fed has artificially propped up the housing market to some extent, and the bubble will begin to deflate once again when this bond-buying slows.
Another scary thought is that homebuilders currently have strong pricing power again. Normally a great thing, the fact that homebuilders haven't possessed significant pricing power in years might cause them to go a bit overboard with regard to home building. We could just as quickly see an oversupply of homes if this were to happen, which would cripple prices and almost assuredly reduce interest in home ownership.
Finally, I simply can't support Trulia, or the sector for that matter, at its current valuation. At 12 times sales and a whopping 41 times forward earnings, there isn't much room for error if the housing sector even remotely slows down.
An investing strategy that stands the test of time
The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.