Zillow's Sell-Off Is an Opportunity for Savvy Investors

Zillow Group (Z 3.29%) (ZG 4.02%) is best known for its informative website that provides home buyers and sellers market data and connects them with realtors. But lately, it's getting into the home buying and selling business. This new endeavor has thrown a wrench into its overall results that is taking the stock down with it. On a Fool Live episode recorded on May 13, Fool contributor Brian Feroldi dives under the covers of the company's latest results and explains why investors should look at the recent stock drop as an opportunity to buy this long-term winner.

Brian Feroldi: I'm pretty sure that most people here are familiar with Zillow, the most popular real estate website in the United States. It's a place you can go and get information about your home. They provide Zestimates on your home. It's basically, historically, it's been a portal for connecting you to a local realtor if you wanted to buy or sell. They earn money through doing that. They've also rolled out a number of other businesses. More recently, Zillow will actually buy and sell your home. They got in to the iBuying business. That threw a wrench into the company's business model, but I think it's going to pay off for investors in the long term.

Let's look at how Zillow has done since it came public. That looks favorable. However, if you look in more recently, this is what the stock has done, down 45%. That's a pretty big drop in a short period of time, although it's not without precedent. Look at Zillow's volatility. This is what? This is just the third-worst drop so far. It just shows you how normal it is for Zillow to be all over the map. If you look at how often did Zillow trade at an all-time high, [laughs] not very often. Yet, if you held, you're doing OK.

Let's look at Zillow's most recent quarterly results. The headline numbers here don't look all that fantastic. I think that most people know that the real estate market is on fire in the U.S. If you look at Zillow's total revenue and see 8% growth, that doesn't sound amazing. But let's dig into the numbers a little bit more. Zillow has a number of different reporting segments. Let's look at the IMT; internet, media, and technology. This is their cash cow, their premier agent. This is their core legacy business where they provide, they get referrals for advertising to local agents. That business was up 38% to 334 million, and their other business, which includes a number of things including their mortgage service business, for example, that was up 26%. That's great.

Their Zillow offers business, which is their home-flipping business, their iBuying business, that was down 9%. The reason for that is all the craziness that's happening in the markets right now with elevated prices, as well as the fact that, during 2020, they actually put this program on pause. They didn't know what was going to happen with the real estate market, so they stopped buying. That dramatically lowered their inventory on it. That is a major reason why revenue is declining year over year, and hence why the total revenue does not look all that impressive. However, if you look further down, you'll notice, look at the gross profit for these businesses or the income for each of these businesses.

The IMT segment is hugely profitable, 143 million, and that is more than offsetting the losses of the home segment, as well as the mortgage segment. Now those other businesses, importantly, are showing lower net losses. The home segment, the net loss for them was down 40% year over year, and the net loss for the mortgages segment was down 86%. That's really good improvement on a year-over-year basis between the two. The home segment is particularly impressive given that the total amount of revenue for it actually fell 9%.

Now, I'm going to scroll up really fast to get more details, so I forgive you if your screen gets a little messed up. Where can I find it? Here are the unit economics of that business on a per-home basis. They sold almost 2,000 homes, and they booked $700 million in revenue on that. Their home acquisition costs, so the cost to get those homes, to buy those homes was $610 million. That's a 13% gross margin. Then if you add in the renovation costs, the holding costs, and the selling costs, this business is rapidly improving. The economics here are rapidly improving. That's really important because a big thesis for owning Zillow stock moving forward is that this business will become a positive contributor to net income. I think that that's going to happen as the company gets more experience with buying and selling homes and as its Zestimates get more and more improved.

I think that Zillow has two really big advantages here over the other iBuying companies. One, it benefits from a cash printing machine that is cranking out profits that give this company unbelievable financial flexibility. Two, and more importantly, in my opinion, is the traffic that this website gets. Zillow gets like 220 million monthly average users that visit its site every month. That is by far the largest [of any of the iBuying websites]. That is is a customer referral program that can't be matched by Opendoor or by Redfin. The number of consumers that are just going to Zillow's websites, and it has a family of websites, that can then be funneled into its iBuying program give it a lower customer acquisition cost than really any other iBuying program can match.

That doesn't matter so much if you're interested in those other iBuying programs because I think the entire category is going to grow tremendously. I don't have the numbers in front of me, but something like 10 million homes, 15 million homes are bought and sold every year. Last quarter, Zillow offers did 2,000. Is there room between those two numbers for Zillow offers to grow, and can Zillow make that business work? I think the answer is yes.

When I see Zillow, I see a category leader with a profitable, fast-growing internet media business, a number of other services that it's getting into, and if they can make their iBuying program work, which the number suggests they're heading in that direction, the upside for this company is huge. Meanwhile, it's run by its founder and has been a winning stock. It's also down 43% from its all-time highs. Mix all that together, sounds good to me.