If today's Duel gets you feeling deja vu all over again, don't call your psychiatrist -- just fire up the ol' Fool archives and you'll soon see what's going on:
Simply put, my esteemed opponent, Rick, is going to recycle the same old criticisms he's been voicing for months about HouseValues (NASDAQ:SOLD). "HouseValues ain't Zillow.com." "HouseValues' business model is broken." "HouseValues took my picture." Yadda, yadda, yadda.
What Rick won't tell you is this: HouseValues is cheap.
And this: HouseValues is profitable.
And finally, this: Wall Street consistently underestimates how profitable HouseValues can be.
HouseValues is cheap
Let's begin at the beginning. HouseValues currently sports a market cap of $270 million and trailing free cash flow (FCF) of $14 million, and it has $83 million in the bank (net of long term debt). Crunch those numbers, and you'll find yourself looking at a fast-growing dynamo of a company that trades at just 19 times FCF. Moreover, if you net out the firm's excess cash, you'll find the business itself trades for (i.e., has an enterprise value or "EV" of) only 13 times free cash flow. And for valuation purists, the company has a PEG ratio (P/E divided by growth) of 0.9.
Granted, these numbers have little meaning until we put them in context. So let's do that. First, analysts predict that HouseValues will grow its profits at 22.5% per annum over the next five years, giving the stock an EV/FCF/G ratio of 0.6 and a P/FCF/G ratio of 0.8. Value investors generally consider a stock to offer an attractive price when the PEG, P/FCF/G, or EV/FCF/G is less than 1.0. In HouseValues' case, any valuation metric you choose tells you the company is trading at a bargain price.
Want more context? Let's compare HouseValues with the broader market. The S&P 500, for example, has a P/FCF ratio of 18 and a projected growth rate of 12.6%. Thus, its P/FCF/G ratio is 1.4.
At the risk of being charged with first-degree mistreatment of a deceased equine, I'll summarize all the above for you now: Whether viewed in isolation, or compared with the gold standard for what investors are willing to pay for an average stock, HouseValues is cheap.
HouseValues is profitable
A couple of months back, Rick took HouseValues to task for slashing its earnings guidance for fiscal 2006. The reason: HouseValues knows it isn't alone in this market, wants to improve its business to fend off competitors, and intends to make the investments necessary to do that -- regardless of what the critics think.
Needless to say, the critics didn't think much of the move, cutting the stock price in half when it issued its new guidance in April. But what the critics -- and Rick -- failed to give HouseValues credit for is the fact that the company continues to grow sales, remains quite profitable on both a GAAP net earnings and a free cash flow basis, and generates free cash flow in excess of its reported earnings. Actually, the firm has a history of producing high-quality "accounting profits"; actual cash profits have exceeded GAAP net income in each of the past five years.
HouseValues is always more profitable than you expect
Maybe it's because HouseValues hasn't been public long enough for analysts to wise up. But whatever the reason, HouseValues has managed to make fools (small "f") of Wall Street's Wisest (capital "w") in each of the past four reporting quarters. In fact, as you can plainly see on Earnings.com, Wall Street has underestimated HouseValues' profitability by an average of 31% over the last four quarters.
So don't be surprised if HouseValues, well, continues to surprise.
That brings me to my conclusion, which is actually fourfold:
- Don't fear Zillow. HouseValues is making the investments it needs to contain this threat.
- Don't believe the fearmongers. Numbers don't lie, and HouseValues' 53% sales growth last quarter tells you that this business isn't broken -- it's booming.
- Don't fear photography. Contrary to Rick's primitive beliefs, it won't steal your soul.
- Oh, and No. 4: Do buy HouseValues. It's a bargain.
Think you're done with the Duel? You're not! Go back and read the other three arguments, and then vote for a winner.
Fool contributor Rich Smith has no position, short or long, in HouseValues, but the stock is a recommendation of Motley Fool Hidden Gems . The Motley Fool has a disclosure policy.
