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Is REA Group a Buy?

REA Group’s (ASX: REA) share price has more than doubled in the past year, comfortably beating the S&P / ASX 200 Index (Index: ^AXJO) (ASX: XJO) rise of 21.5%.

REA’s shares are up 127% over the last 12 months, and a staggering 11,468% since it listed. An average 64% rise in earnings per share over the past 8 years, from 7 cents to 66 cents last year has much to do with the share price rise. And the growth shows no sign of slowing. In the last six months to December 2012, earnings per share rose 24%, as revenues climbed 20% to $161.4 million.

Showing the group’s competitive advantage and strong ‘network effect’, margins have also been growing, as REA has the ability to raise prices, without significantly affecting its revenues or profits. REA owns the leading online residential property business in Australia, with few major competitors. Fairfax Media Holdings’ (ASX: FXJ) Domain business would probably be ranked second, but that would a distant second. As REA recently reported, it saw 19.4 million visits, while its closest competitor saw 8 million visits. 75% of time spent on property sites was on REA Group sites.

But it’s not just Australia that is driving the company’s growth. REA Group also has the number one property site in Italy, with revenues growing 24% in the six months to December. Hong Kong and the Greater Luxembourg Region are also seeing strong growth. Growing profits have also resulted in a burgeoning cash balance. As at December 2012, REA Group had $210 million in cash and no debt.

REA Group is currently majority owned by News Corporation (ASX: NWS), with a 61.6% stake, and speculation is mounting that News Corp could be tempted to launch a takeover over for REA. News Corp is planning to split its publishing arm from the entertainment business, with the stake in REA to be held by the publishing arm, known as New Newscorp. The publishing company will be endowed with US$2.6 billion in cash, so could use those funds to buy out the 38.4% of REA it doesn’t already own. New Newscorp could also divest its stake altogether.

Foolish takeaway

With a forward P/E ratio of over 40 currently, REA Group appears expensive. However, if the company can continue to generate earnings growth as it has in the past, then today’s price may appear cheap. That’s the real issue. How long can REA Group continue to generate growth of more than 20% a year? For now, Foolish investors may want to add the stock to their watchlist, and wait for the company’s first stumble.

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More reading

The Motley Fool’s purpose is to help the world invest, better.  Click here now  for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Motley Fool writer/analyst Mike King owns shares in Fairfax Media.

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