Why Zillow Stock Is Down Almost 50% From Its Highs

Buying or selling a house can be a long, layered, and exhausting process, involving multiple parties. Disrupting the status quo would involve playing the roles of a real estate agent, mortgage lender, and even lawyer. Zillow (ZG 1.75%)(Z 1.88%) is using technology and a high-volume, mass-market business model to help simplify the process for consumers on either side of the deal. 

A physical presence is typically required during several points of the homebuying process. Since Zillow is a technology company digitizing many of these aspects, investors were heavy buyers of its stock during the pandemic, driving it up as much as 660% from the low point set in March 2020. However, the stock price is now cooling off significantly, losing nearly 50% of its value since hitting record highs in mid-February.

The loss can be summed up as the company not quite delivering earnings strong enough to justify its valuation.

Image source: Getty Images.

Zillow is trying to cover all angles

Zillow isn't a one-trick tech company. It's a group of nine brands threaded through all the moving parts of the residential property business -- sales agents, a rental marketplace, broking services, and even home lending. The goal: a one-stop-shop for all things real estate, volume-focused and based online.

The Zillow Offers segment, which directly buys homes from customers and then sells them to a third party, is the biggest part of the business. While it sounds like a mammoth task, it's a simple way to offer a standardized service to both buyers and sellers, removing some of the noise from the sales process. A mountain of data is needed to manage this profitably, with the company's database now filled with information on over 135 million homes. It uses that to create predictive pricing models and generate well-reasoned offers when a customer inquires about selling their house to Zillow. 

Zillow Offers accounted for 59% of the company's $1.2 billion of revenue in Q1 2020. The company sold 1,965 houses and made an average gross profit of $17,634 per unit -- though it did lose money on a net basis. Zillow Offers was followed by the internet and technology segment, which is the most profitable, accounting for 47% of adjusted EBITDA. 

The home lending segment, Zillow Home Loans, is the smallest but fastest-growing contributor with $68 million in revenue -- a 169% jump year over year. 

Zillow has a valuation conundrum

It appears investors expected Zillow to deliver significantly more earnings in 2020, given that the stay-at-home economy offered an opportunity for online businesses to thrive. 

TTM= Trailing 12 months. Data source: Company filings. 

With the stock priced at about $106 a share, it trades at a whopping 101 times trailing-12-month earnings, making it one of the more expensive technology companies by valuation on the market. By comparison, Amazon trades at 61 times the same metric, and it is far more profitable than Zillow. 

As the economy reopens, it appears consumers are falling back into old habits, and the company doesn't project much growth in the second quarter of 2021. It expects just 3% to 7% more revenue compared to Q1, which probably isn't enough to maintain its lofty valuation over the long term. 

A group of 14 analysts aren't overly bullish on earnings either, with the average full-year 2021 earnings estimate sitting at $1.02 per share, according to Yahoo! Finance. The highest estimate is $1.36 per share, which means the company would still have a multiple of 78 times earnings, assuming the share price remains where it currently is.

However, the consensus 2022 earnings estimate is $1.44 per share, representing roughly 40% growth -- that could be strong enough for the stock to maintain today's price, as investors might project that growth rate several years into the future. However, it means share price appreciation might be lacking for now, until 2022 comes around. 

Zillow has a disruptive business with an incredible amount of potential. It has built synergies across its brands that could one day bear enormous fruit. It's still in its early life as a public company, yet has managed to deliver consecutive profitable quarters, something many tech companies struggle to do. Investors should watch earnings growth closely, as the bottom line will be the key driver of the stock's performance at this valuation. If Zillow can grow faster than analyst estimates -- which Q1 results suggest it might -- then the recent near-50% decline might represent good value.