Down 55% From Its High, Is Zillow Stock a Smart Buy?

Historically low interest rates and more remote work have both been catalysts for a red-hot housing market. And despite cooling off recently, the average price of existing homes still sits 10% above last year, and available inventory is still down 13%, according to the National Association of Realtors. Given all these facts, why is Zillow Group (ZG -0.17%) (Z 0.02%) stock price down 55% from its all-time high?

The price plunge is due, in part, to the stock's soaring valuation. After hitting a low in March 2020, share prices of Zillow climbed more than 650% through February 2021. It's not surprising to see a pullback after such tremendous growth.

Image source: Getty Images.

But things got worse for shareholders earlier this week. On Monday, Zillow Offers -- its home-buying business -- suspended the purchase of new homes through the end of 2021. Management cited supply chain headwinds and labor shortages as the cause, both of which affect the company's ability to renovate and resell homes. So here's the question: Is now a smart time to buy Zillow stock?

The largest asset class in the country

Zillow takes a disruptive approach to residential real estate, an industry that comprises the largest asset class in the United States. The company's tech-powered platform connects homebuyers, sellers, and renters with partner agents and landlords. And Zillow also buys homes directly through Zillow Offers, giving sellers the security of an all-cash offer and the convenience of a flexible close date. Of course, this option comes with higher fees, but sellers also avoid the hassle of home repairs and open houses.

To supplement these products, Zillow provides mortgage (purchasing and refinancing), title, and escrow services to homebuyers, eliminating the need for third-party lenders and closing service providers. In short, whether you're looking to buy, sell, finance, or rent a home, Zillow can streamline the process.

Zillow management puts the company's addressable market at over $300 billion. And that figure could get even bigger if it moves into adjacent industries like home insurance or moving services, both of which are on the company's radar.

The best-known brand in the industry

Zillow owns the most popular websites and mobile apps in the real estate industry. Last quarter, these platforms saw a collective 229 million monthly unique visitors, up 5% from the prior year. By comparison, Redfin saw 48 million monthly unique visitors. That scale gives Zillow an edge, allowing it to acquire customers more cost-efficiently than its rivals.

Moreover, its Internet, Media, and Technology (IMT) business -- which generates revenue by connecting partner agents with homebuyers and sellers -- is profitable on a GAAP basis, with a 28% operating margin in the most recent quarter. That reinforces Zillow's advantage over the likes of Opendoor Technologies and Redfin, both of which are unprofitable.

Financially, Zillow has delivered a solid performance over the last three years, on both the top and bottom lines.

Source: YCharts. TTM = trailing-12-months. CAGR = compound annual growth rate.

So what about its decision to suspend Zillow Offers? This is due to circumstances beyond the company's control. Prior to this, Zillow Offers was actually on a good trajectory; it sold 2,086 houses in Q2 2021, achieving an operating margin of 5.6%. That was up significantly from Q2 2019 when it sold 786 homes with an operating margin of 0.5%.

As things stand, the temporary pause on home-buying is set to expire in just a few months (i.e. the end of the year). And Zillow still has 3,142 homes on its balance sheet, meaning it has time to work through its inventory while the labor market and global supply chains normalize. Of course, those situations may take much longer to resolve, but Zillow Offers' improving profitability is still a bullish sign for long-term investors.

Be greedy when others are fearful

Warren Buffett once said: "Be greedy when others are fearful." Now, that doesn't mean you should buy every stock that loses half its value, and it certainly doesn't mean Zillow's share price is done falling. But I believe in this company's growth story. Zillow has a strong competitive position and a massive addressable market, and its ability to simplify real estate transactions will bring more consumers to the platform in the years ahead.

Building on that idea, Zillow stock has an average price-to-sales ratio of 6.8 over the last five years, but shares currently trade at 5.4 times sales, marking a significant discount to past valuations. So if you believe in Zillow's long-term potential, now looks like a good time to ignore the short-term headwinds and buy a few shares of this stock.