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1 Super Stock Down 93% You Might Be Glad You Bought on the Dip

The Consumer Price Index (CPI), which is the widely followed measure of inflation, hit a 40-year high of 8% in 2022. It prompted a significant response from the U.S. Federal Reserve, which lifted the federal funds rate from a historic low of 0.25% all the way to 5.50% in the span of just 18 months.

The real estate industry was hit extremely hard by the policy shift because consumers experienced a substantial decline in their borrowing power. The most recent U.S. existing home sales data (from March) came in at an annualized rate of 4.19 million units, which was down 37% from the 10-year peak of 6.6 million.

Redfin (RDFN 1.06%) is a real estate technology company, and it operates one of the largest brokerages in America. Its business struggled since 2022, and its stock is currently trading 93% below its all-time high. However, interest rate cuts could be on the horizon, which would likely reignite the housing market — along with Redfin’s shares. So here’s why investors might be glad they bought the dip in Redfin stock.

Redfin has adapted to challenging conditions

In 2022, more than half of Redfin’s total revenue came from a practice called iBuying. It involved Redfin’s RedfinNow division purchasing homes from willing sellers and attempting to flip them for a quick profit. This works well when real estate prices are rising, but when the market turns, iBuying companies like Redfin risk incurring substantial losses on their inventory of homes.

Redfin close that business at the end of 2022 as interest rates began to soar, leaving a large hole in its revenue base. Since then, the company focused on expanding its portfolio of services, which include an industry-leading brokerage, rental marketplace, mortgages, and more. These are typically low-cost operations compared to iBuying, so they come with a higher gross profit margin.

Redfin had 1,658 lead agents in the first quarter of 2024 (ended March 31), a number which steadily shrunk over the last couple of years as the company focuses on efficiency rather than outright volume. Those agents helped represent 0.77% of all homes sold across the U.S. during the quarter. While that sounds like a small number at face value, there are more than 3 million licensed Realtors across America, so Redfin’s team is certainly punching above its weight.

The company said 34% of sales came from repeat customers during the quarter. That loyalty stems from Redfin’s low listing fee of just 1.5%, which falls to 1% in subsequent transactions. By comparison, the traditional industry listing fee is around 3%.

Plus, during March, Redfin’s mortgage attach rate hit an all-time high of 30%. It means nearly one-third of consumers who bought a home through Redfin during the month also used the company’s mortgage service. This will help Redfin squeeze more revenue out of each transaction over time.

Here’s what really matters (for now)

Redfin grappled with slowing revenue growth across its portfolio of services over the past year, which is to be expected given the decline in U.S. existing home sales. During Q1, the company’s revenue increased just 5% compared to the year-ago period, reaching $225.5 million.

Gross profit, however, jumped by 22%, partly because Redfin is reaping the rewards of a new compensation structure that has some agents forgoing their salaries in favor of higher commissions.

Redfin’s preferred measure of profitability — adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) — came in at negative $27.6 million, which was a significant improvement from Q1 2023, when it was negative $63.6 million. This has been the primary focus for Redfin during the lull in the housing market; it has to ensure it isn’t incurring substantial losses while waiting for the housing recovery.

According to management’s guidance for the upcoming second quarter of 2024 (ending June 30), Redfin could deliver positive adjusted EBITDA of $2 million, which would be an important milestone on the path to sustained profitability. In fact, the company believes it could deliver positive adjusted EBITDA for the full year.

Why Redfin stock is a buy now

The 93% decline in Redfin stock from its all-time high places the company’s market capitalization at just $750 million. Considering it could generate a shade over $1 billion in revenue this year (according to Wall Street’s forecast), its stock trades at a forward price-to-sales (P/S) ratio of just 0.7.

Redfin stock traded at a P/S ratio of as high as 7.7 in 2021, when interest rates were at historic lows. I’m not suggesting it will return there soon, but it offers some perspective; Redfin’s valuation is currently trading near rock bottom.

According to CME Group‘s FedWatch tool, the Fed is likely to cut interest rates in September and December this year, which will feed through to mortgages, and increase the borrowing power of most consumers. While it’s too early to predict what might happen in 2025, the FedWatch tool indicates there could be further cuts throughout the new year.

As a result, while it might seem counterintuitive to buy a stock that has collapsed by 93%, this could be a great setup for investors who can hold on for the next few years as the interest rate picture shifts back in the real estate market’s favor.

However, buying Redfin stock is not without risk. It has just $107 million in cash on its balance sheet, so achieving positive EBITDA in 2024 is absolutely crucial. With that said, it has a further $165 million in loans held for sale, which should eventually convert to cash and shore up the company’s financial position. I think the risk will eventually be worth the reward.

This post appeared first on fool.com

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