Three Reasons Why Zillow Group's (NASDAQ: ZG) Decline is Not Over Yet

This article first appeared on Simply Wall St News.

Although the real estate prices have been on fire, Zillow Group, Inc.(NASDAQ: ZG), the company that operates the leading real estate and rental website in the U.S, has been on the decline for months.

The stock has been sliding ever since a parabolic run-up early in the year, gapping down as much as 10% on the most recent news.

In this article, we will take a closer look at this decline and examine whether or not it could continue.

View our latest analysis for Zillow Group

Zillow Group could be doing better as it's been growing earnings less than most other companies lately.It might be that many expect the uninspiring earnings performance to recover significantly, which has kept the P/E from collapsing.

You'd hope so; otherwise, you're paying a pretty hefty price for no particular reason.

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Keen to find out how analysts think Zillow Group's future stacks up against the industry? In that case, our free report is a great place to start.

After acquiring over 3,800 properties in Q2 2021, Zillow is suspending the purchases for the remainder of the year. The market didn't take this news kindly as the stock closed 9.37% down for the day.

Here are the 3 reasons why the decline might be far from over:

1. Workforce shortage: COO Jeremy Wacksman quoted labor as one of the reasons for the acquisition pause. It is no secret that there is a countrywide shortage of skilled workers. Both construction and renovation take a wide array of skilled workers – roofers, tilers, plumbers, landscapers, and so on. Delays in just one of those categories can put a brake on the entire project. Despite wages going up, some companies cannot find plumbers even at U$200,000 / year.

2. Real Estate Market Might be Peaking: Although COVID-19 hit many industries, it positively impacted Zillow. Not to mention the inflation, but first, it helped Zillow's Media side of the business as traffic rose, and then it drove the interest rate down, consequentially impacting the mortgage rates. However, according to the National Association of Realtors, mortgage rates rose sharply and above 3% this week. As FED will likely start tapering earlier than expected, mortgage rates will also increase, slowing the real estate sales.

3. Weak Fundamentals: While Zillow turned a profit in the last few quarters, one must keep in mind that this happened in a very strong housing market. It is evident that the next real estate turmoil will thoroughly test the company. While its margins are low (ROE is 2.6%), the price to earnings growth ratio is 2.1x, and the debt to equity ratio has increased over the last few years. Finally, total shares outstanding grew by 11.7% in the previous year, diluting the shareholders.

How Is Zillow Group's Growth Trending?

To justify its P/E ratio, Zillow Group would need to produce outstanding growth well above the market.

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. That's essentially a continuation of what we've seen over the last three years, as its EPS growth has been virtually non-existent for that entire period. Accordingly, shareholders probably wouldn't have been satisfied with the complete absence of medium-term growth.

According to the analysts following the company, EPS is anticipated to climb by 27% each year during the coming three years. With the market only predicted to deliver 12% per annum, the company is positioned for a more robust earnings result.

With this information, we can see why Zillow Group is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

Zillow is Priced for More Real Estate Upside

While the housing market is still booming, it is questionable to stay optimistic about the company with thin profit margins that borrowed heavily to join the real estate flipping craze. Just this new debt attributes to over US$1.1b through bonds priced in August and September.

Although the price-to-earnings and other ratios referenced in this article aren't enough to determine if you should sell your stock, they can be a practical guide to the company's prospects.

The Zillow Group maintains its high P/E on the strength of its forecast growth is higher than the broader market. Still, the real estate market is arguably peaking, and it is the question of whether the company will keep those growth prospects once the inevitable downturn arrives.

Before you settle on your opinion, we've discovered 4 warning signs for Zillow Group (2 shouldn't be ignored!) that you should be aware of.

You might be able to find a better investment than Zillow Group. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).

Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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