Is REA Group expensive?

REA Group Limited (ASX:REA) currently trades on a whopping 39 times last years’ earnings per share, suggesting it is either expensive or set to continue growing at a phenomenal pace.

REA Group’s share price has more than doubled in the past year, comfortably beating the S&P / ASX 200 Index’s (Index: ^AXJO) (ASX: XJO) rise of 21.5%. REA is currently majority owned by News Corporation (ASX: NWS), with a 62% stake.

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.

Has REA Group pushed too far?

The problem is that REA Group has just put through its latest round of price hikes and infuriated agents across the nation. Because the advertising portal is so dominant, for the vast majority of agents, not using it isn’t an option, and have no choice but to accept frequent price rises. That’s the strength of REA Group’s brand, and one reason why its share price has been pushed so high.

But it could also be the company’s Achilles heel.

“It’s grossly overvalued,” Robert Simeon, director of Richardson & Wrench Mosman has told BRW magazine. “They’re having their moment in the sun because print is dead. But it will come to the stage where smarter, more succinct online platforms are developed which will supersede the property portals.”

Several new sites have sprouted, offering real estate agents lower rates and taking advantage of REA Group’s price increases. The attraction for agents of competing sites is additional competition and pressure on REA Group to keep its prices in check.

Domain, which is the number two real estate listing portal and wholly owned by Fairfax Media (ASX: FXJ), has a small market share compared to REA Group, but is taking on REA, and has the more popular Apple iOS app. Other sites, including Onthehouse Holdings’s (ASX:OTH), and are also pressuring REA Group, by offering cheaper  or better products to real estate agents or more free services to entice consumers to visit more often and stay longer.

Foolish takeaway

REA Group may have pushed real estate agents too far this time – it may not take much more to see many jump ship to a competing service or services. That would have a devastating effect on REA Group’s earnings and subsequently the company’s share price.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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