There is no doubt REA Group Limited (ASX: REA) and Carsales.com Limited (ASX: CAR) have been two of the best performing stocks on the ASX over the last five years and both companies have rewarded long-term shareholders. With the recent share price volatility of both stocks, however, investors might be pondering whether this is the end of the great gains they've enjoyed in the past.
REA Group is currently trading at 52-week lows and has had its share price pummeled over the last month since it released its third-quarter results. Although the company increased revenues by 21% and EBIDTA by 30%, it also revealed a 7.2% decline in nationwide residential listing volumes.
Even though REA was able to produce such a strong result despite a reduction in listing volumes, the market is fearful of further reductions in listings, which may impact future growth. With the housing markets so strong in some areas of the country, some sellers are postponing their decision to sell in the hope of achieving a higher price in the future. Two state elections and the Easter break also influenced the result.
While the company may have limited growth opportunities in the domestic residential market, it is establishing a substantial international footprint and introducing complementary products to its current core offering. If, like me, you believe listing volumes will stabilise and eventually begin to increase once sellers decide to put their properties on the market, now may be a great time to invest in this quality company.
REA Group rarely trades on a price-to-earnings (P/E) ratio of less than 30, which is expected for a company with such sector dominance and history of strong earnings growth. Although not cheap compared to the general market, REA Group is currently trading on a P/E ratio of around 27 following a 25% drop in its share price. I believe the market has overreacted and now is an opportunity to start accumulating a quality company with excellent growth prospects.
Carsales.com shares some of the same features of REA Group, including sector dominance, market leading innovation and international expansion. While these features have provided the company with rapid earnings growth in the past, it is forecasting only moderate earnings growth for the remainder of FY15.
With the shares trading on a P/E ratio of around 25, this would suggest the market is expecting strong earnings growth and any disappointment will see the stock price come under pressure. While there is no doubt Carsales.com is a quality business and the market leader, I would wait for the stock price to retreat further before taking a position in the company.
Foolish takeaway
REA Group and Carsales.com both have enviable market positions with excellent balance sheets, but both companies also trade at a premium to the market for their growth potential. Investors need to be wary when market expectations are not met, but I believe this is a good time to start accumulating REA Group with the recent pull-back in its share price. If the share price of Carsales.com falls below $9.50, I would also see this as a good buying opportunity.
