Today we have an extremely speculative idea: take shares in the real estate search and appraisal service Redfin (NASDAQ: RDFN) to capitalize on the boom in this area.
Growth potential and tenure: 26.5% in 18 months; 10% per year for 10 years.
Why the stock may rise: Buying the company is a very likely option.
How we do it: take the stock now at $79.03.
Our thoughts are based on analysis of the company’s business and personal experience of our investors, but remember: it is not a fact that the investment will work the way we expect it to. Everything we write is forecasts and hypotheses, not a call to action. Whether or not to rely on our thinking is up to you.
And what about the predictions
Studies such as this one and this one suggest that the accuracy of target price predictions is low. And that’s normal: there are always too many surprises in the stock market, and accurate predictions are rarely realized. If the situation were reversed, then funds based on computer algorithms would perform better than humans, but alas, they perform worse.
That is why we do not try to build complex models. The return forecast in the article is the author’s expectations. We specify this forecast as a guide: as with investments in general, readers decide for themselves whether to trust the author and be guided by the forecast or not.
What the company earns from
This is a site for buying and selling real estate. According to the annual report, the company earns revenue from commissions on home sales and purchases. The company’s revenue structure is divided into four segments.
Operations on the purchase and sale of real estate. The segment brings in 63.6%. Here the company acts as an agent representing the interests of the seller or the buyer. The gross margin is 28.7% of the segment’s revenue.
Revenue from real estate. The segment’s revenue is 30.5%. The company earns from the direct purchase and sale of homes from homeowners. The segment’s gross margin is negative – 1.9% of its revenue.
Affiliate revenue. Realtor revenue from the referral program is 3.5% of all revenue. The gross margin here is unknown, because when calculating profitability, affiliate revenue was included in the first segment.
Other. Mortgage and property insurance assistance, advertising and evaluating residential pedestrian metrics. The segment’s revenue is 2.4%. Here too, the margin is negative 9.1%.
The company operates only in the United States.
Arguments for the company
The main advantages are the same as those of Zillow. In December we published a review of a similar company, and there the main advantage was that the company is a technological startup in a traditionally offline environment. This gives good prospects for the growth of Redfin’s business indicators. For example, Amazon grew due to the low level of digitalization of retail, while the sector as a whole stagnated in the United States.
The timing is very good: as you remember from the reviews of Toll Brothers and Beacon Roofing Supply, there is a real estate boom in the United States. And this creates additional opportunities for Redfin. Large institutional investors are coming into the U.S. real estate market. And that greatly increases the likelihood of buying the company, even though it is unprofitable.
Redfin’s main value, like Zillow’s, is not its business. It is its software and constantly improving algorithms that allow you to buy and sell real estate at market prices. Compared to conventional real estate businesses, Redfin looks very good. The average selling price for a seller is $1,900 higher than offline, and when selling and buying homes in similar categories, the savings is $11,800. Through Redfin, realtors close three times as many deals and earn twice as much as they do offline. In the U.S., private foundations working in real estate, accumulated free 335 billion dollars – and someone from the major players could well buy Redfin. The company’s capitalization is about $8 billion, so it would not be difficult.
The purchase of the company is not guaranteed, but the probability is high. And even without a purchase, Redfin has a good basis for growth: the American real estate market is already ripe for the introduction of new technologies.
What might get in the way
Price. The company is now trading near historic highs, and yet it is loss-making – a guarantee of stock volatility. They could well fall by as much as half, given that the value of technology companies in the U.S. is dangerously close to the level of the era before the dot-com crash. If it turns out that the company halves in price first, and then someone buys it, that would be the least interesting option for us.
Financing unprofitable operations requires sacrifices. Judging by the absence of large debts, the company is financing its operations by issuing new stock. This is not good, because if supply exceeds demand, the stock will fall, most likely very hard. On the other hand, since the beginning of the year, publicly traded U.S. companies have raised record amounts by issuing additional shares – and nothing, the market is growing. So there is a possibility that Redfin will be able to issue additional shares with impunity.
This music will not last forever. When the excitement in the U.S. real estate market subsides, it may have a negative impact on a company’s capitalization. It’s unlikely to affect its business performance because American realtors have a lot to digitize, but the stock of all real estate-related companies will suffer.
What’s the bottom-line
Despite the huge risks, you can take a risk and take the stock now at $79.03 per share and sell it for $100 within the next 18 months. The potential of the company’s software and algorithms will outweigh both the current high cost of shares and other negative factors. The company will either be bought or it will gradually reach profitability and its value will grow from the influx of investors. The more so that the previous quarter the company finished in profit.
Or you can hold that stock for the next 10 years in anticipation of more significant growth.
But at any rate, it’s a very risky and volatile idea – and if you’re not prepared for the fact that the stock will shake, it’s better to stay away from it.