Zillow’s stock price has taken a beating over the past six months, shedding 39.8% of its value and falling to $41.50 per share. This might have investors contemplating their next move.
Is there a buying opportunity in Zillow, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Do We Think Zillow Will Underperform?
Even with the cheaper entry price, we're sitting this one out for now. Here are three reasons you should be careful with ZG and a stock we'd rather own.
1. Revenue Spiraling Downwards
Examining a company’s long-term performance can provide clues about its quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Zillow’s demand was weak over the last five years as its sales fell at a 5% annual rate. This wasn’t a great result and is a sign of poor business quality.
2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Zillow has shown poor cash profitability relative to peers over the last two years, giving the company fewer opportunities to return capital to shareholders. Its free cash flow margin averaged 10.6%, below what we’d expect for a consumer discretionary business.
3. New Investments Bear Fruit as ROIC Jumps
We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. On average, Zillow’s ROIC increased by 1.7 percentage points annually each year over the last few years. This is a good sign, and we hope the company can continue improving.
Final Judgment
Zillow doesn’t pass our quality test. After the recent drawdown, the stock trades at 18.8× forward P/E (or $41.50 per share). This valuation tells us a lot of optimism is priced in - you can find more timely opportunities elsewhere. We’d recommend looking at our favorite semiconductor picks and shovels play.
Stocks We Would Buy Instead of Zillow
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