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Brokers warn this top performing S&P/ASX 200 stock could tumble

The happy days for investors who piled into Australia’s largest online property classifieds business REA Group Limited (ASX: REA) are about to diminish with arch-rival Domain nipping at its heels and as two leading brokers downgrade the stock.

But don’t expect any tears of sympathy.

REA Group has been running hot with the stock clocking gains of 46% over the past year when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) is up 12%. This makes REA Group one of the best performing stocks on the index as it surged to a record high of $76.41 yesterday.

This performance gap could be about to close though and this could be an opportune time for shareholders to take some profit off the table as the stock is starting to look stretched.

UBS downgraded the stock to “sell” from “neutral” even as management posted a 21% uplift in first quarter revenues to $190 million thanks to a strong rebound in listing volumes in the Sydney and Melbourne residential market.

The group also managed to control its costs well, leading to a widening “jaws”, or operating margin, but this may be unsustainable as the improved margin is largely related to the timing of key promotional events than actual cost savings.

This has led UBS to question if this is as good as it gets for REA Group in terms of jaws as management tipped a somewhat softer outlook for the rest of the year.

While there isn’t anything fundamentally wrong with REA Group, it’s hard to justify its lofty price-earnings (P/E) multiple of nearly 36 times (based on UBS’ FY18 estimates). I couldn’t agree more.

Market darlings that trade on a hefty premium to the market are particularly vulnerable to tripping up – just look at Domino’s Pizza Enterprises Ltd. (ASX: DMP).

It isn’t only UBS that has rung a warning bell on the stock. Credit Suisse has also downgraded the stock to “neutral” from “outperform” following management’s outlook commentary and on valuation grounds with the broker highlighting property market volatility as a key risk.

Let’s also not forget that Fairfax Media Limited (ASX: FXJ) will soon be spinning out Domain as a separately listed entity. The CEO of the new public company will be hungry to impress early and this could mean it will launch an aggressive campaign to win more market share.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. 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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