Why I Decided not to Buy Zillow
Saul is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
At first I was really excited about Zillow (NASDAQ: Z). I read back through the last four earnings reports. I read lots of comments about it. I thought about it a lot. I ended up feeling that the company will do fine, but as an investment the stock was limited and I decided not to buy. Here’s why:
To start off with, I gave them the benefit of the doubt and instead of using GAAP earnings per share, I used their adjusted EBITDA. That means that all their depreciation and amortization and stock-based compensation was added back in to their net income to raise their apparent earnings per share.
I then figured each quarter's earnings as if they had the same 31 million shares they have now to make them comparable after the IPO. Finally I figured a 35% tax rate to figure a sustainable earnings rate. (No company can go indefinitely on tax write-offs, especially if they make much money).
At the end of 2011 their 12-month trailing earnings were 24.5 cents. Their current price is roughly $40. That gives them a PE ratio of 163. (And that, let me repeat, is after adding back all the amortization, depreciation and stock-based compensation expenses).
They did double their revenue (and more) from 2010 to 2011, and did again in the March quarter.
However, March was the LAST quarter that they will double revenue. (Their last four quarters revenues were $15.8, $19.1, $19.9 and, in March, $22.8 million. Thus their last three SEQUENTIAL increases averaged $2.3 million. To double next quarter’s $15.8 million, they’d need $31.6 million, or a sequential increase of $8.8 million from March's $22.8 million.
It’s not going to happen. And doubling the next quarter after that’s income would be even harder, requiring $39.2 million).
Okay, that’s a pretty clear demonstration that the days of doubling revenue each quarter are over. How about earnings?
Well, we can hope that their margins improve and they double earnings anyway in 2012, even without doubling revenue. That would give them 49 cents. Let’s even say they increase earnings by 110%. That gives them 2012 earnings (as of early February of 2013, when they are announced) of 51.5 cents. That still gives them a PE ratio of 78.
How about 2013? Let’s give them a 60% revenue increase. And let’s assume no hiccups and no problems and that they increase adjusted earnings by 70%, giving them (in February 2014) trailing earnings of 87.5 cents. Thus at today's price, in February 2014, they’ll still have a PE ratio of 46 times.
So where is the stock going to go? How am I going to get a profit on my stock? And how in the world could I expect to double my money any time soon.
A double by February 2014 means a stock price of $80 and a PE ratio of 92. If you believe in that you believe in the tooth fairy. A triple would be even more insane.
And remember, this is allowing for no bad quarters, no mistakes, no expensive investments, and adding back everything I could to earnings.
So, sorry, I like the company, I like the collaboration agreement with Yahoo (NASDAQ: YHOO), I like Zillow's chances to keep growing, but I don't like the stock. One bad quarter and a trailing PE of 160 could drop to a trailing PE of 50... in a flash!
SaulR80683 has no positions in the stocks mentioned above. The Motley Fool owns shares of Zillow. Motley Fool newsletter services recommend Yahoo! and Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
