The problem for ZG stock is that the narrative has changed. Investors thought they were getting another capital-light Internet platform, one with high margins and impressive growth. Zillow had the potential to not necessarily transform the real estate sector, but by selling advertising and leads to realtors, at least carve out a nice share of that massive industry.
For Zillow management, however, that doesn’t seem to be enough. As InvestorPlace’s Dana Blankenhorn detailed earlier this year, ZG stock has become a bet on house-flipping. Zillow is moving into mortgages as well. For investors who lived through the financial crisis of the last decade, “innovation” in the real estate market is a reason for caution, not optimism. And that is one of the reasons why Zillow stock has struggled of late.
That said, it’s not at all guaranteed that Zillow management is wrong. Indeed, if they’re right, the rewards here are enormous, as Zillow gains a bigger portion of the lucrative real estate market. First quarter earnings, due Thursday afternoon, give Zillow management another chance to show why its strategy makes sense.
Zillow Earnings Expectations
I wrote ahead of the Q4 report in February that the earnings report was key for ZG stock. That turned out to be both true and false. ZG stock gained 25% on the report, in part due to the news that founder Rich Barton was returning to the CEO post.
But those gains would fade. Within six weeks, ZG shares were back to pre-earnings levels — and they kept falling. A recent rally leaves ZG stock about where it was before the fourth quarter report.
That’s true from a price standpoint and from a ‘feel’ standpoint as well. In both senses, Zillow stock is right back where it was almost three months ago. And that presents an opportunity with the first quarter release.
The Contradiction Behind ZG Stock
The catch with ZG stock in this market is reasonably simple. Investors at the moment like tech stocks — of almost any kind. Admittedly, it remains to be seen whether that will remain the case. As I wrote on Friday, Zillow earnings are just one of three key earnings releases for Internet platform stocks, with Yelp (NYSE:YELP) and Etsy (NASDAQ:ETSY) also reporting. It’s possible, if unlikely, that those earnings could dim the appetite for Internet platform stocks starting next week.
Barring that, however, Zillow stock will occupy an odd place in investors’ eyes. Those investors like tech. But Zillow’s new initiatives aren’t really about tech. To be sure, Zillow plans to use data analysis in its Instant Offers program, and the same likely will be true of its potential entrance into the mortgage market. But the end markets – housing and banking – are not markets that investors favor at the moment.
In fact, investors dislike those markets. Housing stocks have rallied so far in 2019, but multiples in that industry generally trend toward the single-digits on a P/E basis. The same is true of big banks like Bank of America (NYSE:BAC) and even JPMorgan Chase (NYSE:JPM), when looking at 2020 estimates.
So what Zillow is doing, at least from an investment standpoint, is somewhat bizarre. Old-line companies are looking to satisfy investor demands by establishing recurring revenue; see, for instance, the efforts of Cisco Systems (NASDAQ:CSCO) to add SaaS offerings to its legacy hardware business.
Zillow is going the other way. It’s adding on a cyclical, capital-intensive business model to the high-margin platform investors bought in the first place. It’s no surprise that many of those investors have decided to look elsewhere.
What Moves Zillow Stock Higher
In that context, the Q1 numbers from Zillow may not matter all that much. The issue here is long-term strategy, not short-term performance. The reaction to the Q4 report, even if it took some time, proved that point.
And so the response to the Q1 report may not come down to whether or not Zillow beats or misses consensus estimates. It’s more likely to be based on whether Zillow management, with another opportunity, can convince investors that its new strategy is better than the old one.
In this market, it will be a tough sell. That’s not to say Zillow’s strategy is wrong; in fact, it’s rather intriguing. But it will take years, not a single quarter, to prove that Zillow management is making the right decision. As such, expecting Q1 results to move ZG stock higher may be asking for too much.
As of this writing, Vince Martin has no positions in any securities mentioned.