Profit up 26% but REA shares fall 4.4%. What gives?

REA Group (ASX: REA) CEO Greg Ellis must wonder what he needs to do to make the market happy.

It’s a tough day for a CEO when he turns in a profit that is a full quarter higher than the previous year, and investors respond by wiping $190 million off the market capitalisation of your company – but that’s exactly what happened yesterday.

Of course, with shares up 140% over the past 12 months, investors were already expecting something special – REA had outpaced the S&P / ASX 200 (ASX: XJO), (Index: ^AXJO), by a factor of 7 times!

REA has also won the battle of the classifieds companies over the past year, with employment site Seek (ASX: SEK) and auto-listings business (ASX: CRZ) both showing the ASX 200 a clear pair of heels, up 49% and 46% respectively, but still a long way behind the real estate king.

The owner of the dominant website (as well as some investments in overseas real estate listings businesses) grew its top-line revenue by 21% and average revenue per agent (in Australia) by 26%. Offsetting that was a lack of growth in the number of agents using its system (perhaps unsurprising) and a slight decrease in the number of listings.

With effective saturation of the market in Australia, REA is taking the tried and tested ‘do you want fries with that approach’, but upselling home sellers to more expensive packages – called ‘depth’ products by the company.

It’s a good strategy – after all, if you’re selling a home for hundreds of thousands of dollars, the value proposition of spending a little more on the listing fees potentially offers a nice return on investment when it comes to maximising the interest in your property and/or getting the best price at auction.

The company says it is extending its lead over competitor, owned by Fairfax Media (ASX: FXJ).

Foolish takeaway

Of course, the question investors must answer is how long the company can continue to charge more and more for its listings – given the market dominance it already enjoys, it’s a fair bet that increasing the number of agents or properties will be tough – and the pace and success of its international expansion.

With a P/E approaching 40 times earnings, today’s shareholders are fervently hoping the answer is “for a long time to come.”

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Motley Fool advisor Scott Phillips doesn’t own shares in any company mentioned in this article.

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