Despite high inflation in 2021, rising interest rates, and a slowing economy in 2022, the travel industry has been in a bull market for a while. If the massive demand for U.S. passports is any indication, 2023 could be an even bigger blockbuster year for travel, and what company benefits more from travel and tourism than Airbnb (ABNB 0.75%)?
The company has had a great start to the year. The stock rose 41% even before it reported its fourth-quarter 2022 earnings, and tacked on an additional 13% the day after its earnings release. So investors liked what they saw.
Considering that the stock has already had a 36% run year to date, should you buy into this vacation rental company or remain on the sidelines and wait for a better valuation?
Airbnb has substantial competitive advantages
The business began in 2007 when two hosts, Brian Chesky and Joe Gebbia, the co-founders of Airbnb, opened up their San Francisco apartment to three guests. That has since expanded in 2022 to more than 4 million hosts renting out spaces to over 1.4 billion visitors in 100,000 cities and towns globally.
With hosts on one side and guests on the other, Airbnb is the perfect example of a company with a double-sided network effect -- a decisive competitive advantage. With each new host joining the platform, the service becomes much more valuable for guests, and each new guest who rents through the platform creates additional value for hosts.
As a result of Airbnb's value to hosts and renters, travel industry experts estimate it has captured at least a 20% share of the vacation rental industry, a massive scale that will be hard for competitors to duplicate. Another competitive advantage Airbnb has is that it is one of the best-known brands in the travel industry: It's not only a noun but has also become a verb. That means, in practical terms, that when many people want to travel, they consider starting their search for an available vacation housing spot on Airbnb.
As a result, as far back as 2019, the company learned that it could still grow by simply using cheaper brand advertising rather than paying for more expensive search advertising. Airbnb's marketing spending is far more efficient than most smaller competitors relying on Alphabet's Google Search to drum up business. Consequently, Airbnb gets more bang for the advertising buck.
The vacation rental market is very competitive
Although it has positioned itself well in its industry, the one thing shareholders must monitor is competition. While large online travel agencies like Booking Holdings and Expedia Group were asleep at the wheel when Airbnb first emerged on the scene in 2007, they are awake now.
Expedia Group first dipped its toes into the vacation rental industry when it acquired a company in 2015 named HomeAway, which owned a company called VRBO. It operates similarly to Airbnb and started in 1995, but it took far longer to gain in popularity. So in March 2019, Expedia rebranded VRBO to Vrbo, and by June 2020, it had folded the HomeAway brand into the Vrbo brand.
Today, Vrbo has just over 2 million listings, compared to Airbnb's 6.6 million global listings. But you can be sure Vrbo is committed to grabbing market share from its larger competitor.
Expedia plans on attacking Airbnb's network-effect advantage through its new One Key loyalty program, which includes many Expedia Group brands like Vrbo, Expedia, Orbitz, Hotels.com, and others.
As for Booking Holdings, although its European-based Bookings.com has much lower brand recognition in the U.S. for vacation rentals than Vrbo and Airbnb do, it is a formidable competitor that both companies must be aware of. Historically, Bookings.com has focused chiefly on flights and hotels, but has recently started concentrating on vacation rentals. So Airbnb shareholders should monitor Bookings.com's success or failure in the vacation rental market, especially in the U.S., where the European travel brand needs to do better.
Heavyweights like Alphabet and Alibaba could decide to enter the arena even more aggressively, and we won't even talk about the new vacation rental start-up backed by Jeff Bezos named Arrived Homes. So there's no guarantee that Airbnb's competitive advantage will last over the long term. If you decide to invest in the company, you should continuously monitor its position on a competitive playing field.
Should you buy Airbnb stock?
While competition in the market is fierce, the company is putting up outstanding numbers that are highly attractive to investors. For example, it grew 2022 annual revenue by 40% over 2021 to an astounding $8.4 billion. More impressively, 2022 was the first time the company generated annual profits under generally accepted accounting principles (GAAP), with a net income of $1.9 billion.
The cherry on top is its 2022 annual free cash flow (FCF), which was 49% higher than the previous year at $3.4 billion. It is hard to find a company growing revenue by double digits that's also producing significant profits and FCF in today's challenging market. However, Airbnb shareholders have reached that promised land.
Its price-to-earnings (P/E) ratio of 42 is almost twice the overall internet services and social media industry's P/E of 24, but some think the market is undervaluing the stock's prospects. If you are a growth investor searching for a bull market, there are few better places today to invest your hard-earned money than the vacation rental industry and its lead dog, Airbnb.
