Good Short
If you feel confident in an investment in this space, then there is no doubt that Zillow is by far the better company. The stock’s short ratio, and that of Trulia, was due to a number of bearish articles, most notably by Citron Research, that question the valuation on the space. Now, with strong earnings, there are a lot of investors who are more optimistic, and are willing to place large valuations on these two companies. However, you must not forget the valuation-related concerns that had disallowed the stocks from trading with momentum over the last several months.
Zillow, is trading with a price/sales of 12.09 and a forward P/E ratio of 54.79; Trulia also trades with a price/sales over 12 and is not profitable, nor is it close. In some ways I can understand the market’s valuation for Zillow. It’s an efficient business and is fast-growing. And although I wouldn’t buy at these levels, I must acknowledge the fact that it trades with a price/sales that is much less than Facebook Inc (NASDAQ:FB) yet is growing twice as fast. The reason this is relevant is that the market awards higher price/sales and P/E multiples to stocks that are fundamentally growing fast. Once growth slows, and expectations aren’t being met, these ratios are typically supposed to decline.
I view Zillow as overvalued, but not too expensive. Trulia on the other hand is along for the ride, and is trading higher because it is growing yet remains an unprofitable company that lacks efficiency. In my opinion, a price/sales of 12.24 is way too expensive for this stock, and as a result I view it as a prime short candidate.
Conclusion
The important thing to remember about these social media stocks and the high valuations that they sport is that there is limited revenue in one segment. Zillow and Trulia can only grow with real estate; neither will ever become Priceline.com Inc (NASDAQ:PCLN) or Google Inc (NASDAQ:GOOG) with hotel and search businesses. These are two companies that still have revenue upside, but it is unknown as to whether or not agents will continue to utilize these sites once the real estate market recovers.
Far too often we connect companies and compare stocks that are fundamentally different; such is the case with Trulia and Zillow. Trulia is way too expensive compared to fundamentals and Zillow might be worthy of its valuation due to efficiency and the gold standard that values a company in the social media space. Either way, I warn investors of chasing the quick gains with either company, and suggest that investors wait before buying Zillow and prepare to short the overpriced Trulia.
The article Two Stocks, One Overvalued Industry Worthy of a Short originally appeared on Fool.com and is written by Brian Nichols.
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