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Mcgrath Ltd shares slide despite growth in Melbourne property market

Credit: Mark Robinson

Shares in real estate agent Mcgrath Ltd (ASX: MEA) dropped around 1% today, despite the business announcing the opening of its first Melbourne office, with plans for three more to come in 2016.

The expansion into Melbourne was no secret, although it remains one of the best residential real estate markets in the world alongside Sydney, which is a city McGrath has built much of its success in.

Indeed, much of McGrath’s growth potential would appear to revolve around growing its operating footprint either by opening up more company owned or franchised offices within Melbourne in particular, but also elsewhere in the regions outside its Sydney power base.

During the float the shares were offered at $2.10 on around 13.4x net profit after tax with a forecast dividend yield in the region of 3.7%. Since then however the stock has dropped around 11% as investors conclude that a real estate agent does not look a great investment opportunity. Below are some of the reasons why investing in real estate agents might not be a good long-term bet.

  • No real competitive advantage over rival real estate agents who may seek to undercut commission rates offered to vendors
  • The company’s revenue streams are not guarded by a moat as property vendors are free to choose any agent they like to sell their property
  • Vulnerable to disruption as new technology or websites lead to increasing private sales between buyers and sellers transacting directly
  • Low barriers to entry means new competitors can enter and disrupt market
  • Acquisition strategy carries risk over funding and integration, an acquisition strategy would also carry some dilution risk via capital raisings if not funded from profits

In my opinion the above reasons are more than enough to explain why investors should not consider McGrath or any other traditional real estate agent investment grade over the long term. Investors should also consider the timinig of the float and the fact that McGrath insiders may soon have the option to cash in on their equity interests in the business.

Although, in fairness McGrath does have a strong brand, decent track record and leverage to Australia’s strongest single asset class for most people over the long term in property.

However, long-term investors should look to companies with genuine competitive advantages that provide potential for them to consistently grow profits long into the future. Two of the best are digital advertising businesses  SEEK Limited (ASX: SEK) or Carsales.com Ltd (ASX: CAR), while the three others revealed below may be even stronger performers.

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

You can find Tom on Twitter @tommyr345

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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