Summary
- I make the case that even though the past 18 months have been challenging (read disaster), 2023 is set to be a winner for the company.
- The best time to buy a secular compounder is when the business is down 50% or more from its highs.
- Zillow has had to tackle substantial issues in 2022. Some of them are of Zillow's own making. Some are outside of Zillow's control. Meaning that risks are still present.
Investment Thesis
Zillow Group's ( Z ) ( ZG ) business model is directly tied to the health of the residential real estate market. That's the key notable risk. But also, that's Zillow's opportunity.
Last year, Zillow needed to address various complications. Several of them were Zillow's own creations. While other aspects were beyond Zillow's control.
Now as we look ahead, Zillow has an opportunity to profitably grow over the next 12 to 18 months and investors are not fully pricing in that potential in my view.
Why Zillow is Coiled and Ready for a Comeback
Consider this ETF below.
This is a home construction sector ETF. It's a proxy for sentiment toward homebuilders. It includes homebuilders, providers of mortgage financing, and real estate services.
When the Fed stated its intention that rates were going to start significantly tightening, this ETF dropped 40%. The housing market went into a tailspin. And indeed, frankly, presently housing activity is still suppressed.
But what you see here is not the housing activity per se , but rather what the market is attempting to price in around the quarter. What the market is seeing is a strong rebound in housing activity.
To sum up my argument, I believe that right now, when Zillow is still down more than 60% from its highs, this is an attractive time to get involved with the company.
Zillow's is the go-to place for real estate listings. Its name carries value. It carries goodwill values that are not reflected in the immediate financials . What a strong brand provides is the opportunity to continue compounding its growth into the future.
2023, A Year of Change for Zillow
A lot of the drawdown that Zillow had since 2021 was self-inflicted. The business tried to pivot. It tried to get involved with iBuying. And unlike other investors, I don't blame management for being entrepreneurial. I salute them.
After all, isn't that what some of the best companies in the world do? You must innovate or die.
My argument here is that Q4 is expected to see Zillow's IMT segment, which is its advertising segment, fall 19% y/y. But when we start to look further ahead a few months, with housing prices starting to find their footing once again, Zillow will be extremely well positioned to retain and expand its market share.
What's even more exciting, is that when a business has seen its share price fall more than 60%, management is forced to make difficult decisions. This goes beyond just slimming down its headcount.
It's a change in corporate culture, from one of surplus to one that values frugality.
Zillow Stock Valuation - Thinking Through its 35x Forward EPS Figure
If I were to boil down my bullish thesis to one element, it would be this, Zillow's 2023 will be up against much easier comparables.
It's no longer fighting against a contracting housing market. Even if the housing remains largely flat and doesn't actually move up much, from the investment perspective that's a world of difference.
Investors' perception goes from a business that's shedding its iBuying business, cutting back its workforce, and facing a contracting housing cycle, to something that is a lot more mundane. Something that's stable.
Investors can price in ''stable''. Stable is perfect for investors. What investors struggle with is uncertainty.
Zillow is probably priced at somewhere around 35x forward EPS. I'm not going to make the case that this multiple is particularly cheap.
But what investors that focus squarely on the forward EPS figure sometimes miss, is the argument that I made, that Zillow is now over the worst.
The Bottom Line
It's difficult not to be bullish on Zillow.
That being said, in the interest of full disclosure I've been bullish on this name since it was priced at $93 and with the stock, down 50% I was clearly very wrong on this name so far.
That being said, having called this stock so wrongly, I've had the chance to learn much more about what aspects I didn't fully grasp previously.
In sum, investors shouldn't be thinking about where Zillow's earnings will be in 2023. Investors should think about Zillow's exit run rate from Q4 2023. In twelve months, what will the investors then think about Zillow? That's where the opportunity lies.
For further details see:
Zillow Group: Back To Secular Growth