The REA Group Limited (ASX: REA) share price has fallen by around 8% since its high at the end of June, but is still up by more than 23% over the past year.
Considering the valuation is currently at 34x FY19's earnings, I think it's worth consider whether REA Group is a good buy at today's price:
Not a good buy because
- The valuation alone should make most investors stop and think. Anything with a price/earnings ratio above 30 is pricing in a lot of growth for the next few years.
- Rising interest rates are expected to have a contracting effect on shares that are defensive and also ones that have high p/e ratios like REA Group.
- The housing market is steadily falling in the key cities of Melbourne and Sydney. This may cause homeowners to decide not to list their property and wait. Less houses on the market means less advertising revenue for REA Group.
- Competition could be about to heat up from Domain Holdings Australia Limited (ASX: DHG). One of the main reasons for the suggested merger between Nine Entertainment Co Holdings Ltd (ASX: NEC) and Fairfax Media Limited (ASX: FXJ) is to focus on accelerating Domain's growth.
It is worth buying because
- Businesses with powerful business models and brands are worth holding for the long-term, despite the higher valuation, due to their powerful compounding profit effects. REA Group owns the most popular property site in Australia, which attracts the most buyers and sellers, allowing it to increase prices at a good rate every couple of years.
- The high valuation might be justified considering it is still unveiling revenue and operating profit growth of 20% or more each quarter compared to the prior corresponding period. It can grow into its valuation in time.
- Although the property market is stalling this could actually be a good thing for REA Group. More time on the market means more advertising revenue for REA Group. It also means vendors are more likely to pay up for the higher-costing ads to stand out from the competition.
- REA Group is diversifying its earnings in Australia by adding other services like mortgage broking and property data services.
- Its stakes in overseas property sites in Asia and the US could drive revenue and profit higher as those regions recognise the value of online property advertising.
Foolish takeaway
It's hard to say whether it's a clear buy or sell. If I were an active investor I'd consider selling today, but I think most investors should hold for the long-term. However, I also personally wouldn't buy today either.
I wouldn't consider buying shares until the forward p/e is at least under 30x.
