It’s been about 18 months since I recommended investors continue to avoid Redfin Corporation in an article with the stupendously creative title “Continue to Avoid Redfin Corporation” (NASDAQ:RDFN). In that time, the shares are down about 49% against a gain of about 4% for the S&P 500. The company just released earnings again, so I thought I’d check on the stock yet again to see if it makes sense to actually buy now, given that a stock trading at $6.25 is definitionally a less risky investment than a stock that’s trading at $12.20. I’ll review the latest financial results to see if there’s reason to actually buy this stock at the moment. I’ll make that determination by reviewing the financial results, by looking at the valuation, and by comparing all of that to much lower risk alternatives available to investors. After all, if an investor can receive 4.5% risk free, a stock such as this should offer much more than that to compensate for the risks associated with owning this stock.
My regular readers know that I’m absolutely driven to make their reading experiences as pleasant as possible. That’s why I put up a thesis statement paragraph quite near the beginning of my articles. This gives you the opportunity to quickly get the gist of my argument, and then get out before you’re exposed to too much of my “dad humour” or proper spelling. You’re welcome. I’m perplexed by the market’s positive reaction to this stock since the company reported earnings, because I consider earnings to be lackluster at best. The strange negative relationship between sales and earnings lingers, but from a different direction this time. Although the stock looks quite cheap by some measures, the relativistic nature of investing at the moment suggests that this stock is a great example of a value trap. I wish I could buy, because I like names that have been beaten up, but there’s nothing worth buying here in my estimation.
Financial Snapshot
When reviewing I’ve made a “big thing” about the fact that there seems to be no obvious connection between revenue and net income with this business. Traditionally, the more the company sold, the greater were its losses. I went so far as to compute the relationship between the top line and the bottom line, and I found that there has been a strongly negative (r=-.84) correlation between sales and profits. I updated this analysis, and to the end of December 2022, the relationship had widened slightly, with a negative correlation now of r=-.87.
For the first nine months of 2023 the negative relationship between revenue and net income persisted but in an unexpected (to me) way. Revenue for the first three quarters of this year was lower by about 13.5%, but net loss has shrunk by just under 59%. So previously I asked the question “if growing sales won’t lead to profits, what will?” it seems that lowering sales may have a net positive effect on the company’s financials. This is an eccentric situation in my view.
I couldn’t live with myself if I didn’t write about stock based compensation here. I like to live with myself, so I’m going to write about stock based compensation. From 2016 to now, the company has spent about $283.1 million on stock based compensation, and per employee compensation jumped about 45% in 2022 relative to 2021, bringing average per employee compensation in that year to $12,250, up from $8,438 the previous year. At least the 5,572 employees the company had on staff in 2022 did relatively well on average.
Finally, we need to acknowledge that the capital structure is no longer as strong as it was. Relative to the same time last year, for instance, cash and short term investments are down by about $757.7 million, or 82%. This trend is not a good one, obviously.
In spite of all of this, I’m a fan of buying stocks that are deeply out of fashion, and are suffering from a great many headwinds at the moment because, in my experience, markets overreact on both the upside and the downside. Thus, I’d be willing to take a proverbial “flyer” on this troubled name if the relative valuation is reasonable, and if it’s possible to make an outsized, risk adjusted return from current levels.
Redfin Financials (Redfin investor relations)
The Stock
If you read my stuff regularly, you know that I measure the cheapness of a stock in a few ways ranging from the simple to the more complex. On the simple side, I look to ratios of price to some measure of economic value like earnings, sales, and the like. I also use methods described in Penman’s “Accounting for Value” and Mauboussin and Rappaport’s “Expectations Investing” to work out what the market is currently “thinking” about a given stock’s future prospects.
We see from the following that even after the recent uptick in price, the market is paying very near an all-time low for $1 of sales.
Source: YCharts
As I wrote above, in addition to looking at simple ratios, I also look at more complex measures of valuation. As I wrote, I want to try to unpack the assumptions currently embedded in price. If you read me regularly, you know that I rely on the work of Professor Stephen Penman, and increasingly Mauboussin and Rappaport to do this. This approach uses stock price itself as a source of information. This method involves using a bit of high school algebra to “reverse engineer” the assumptions that cause the current price. According to this methodology, the market is currently forecasting that the company will be bankrupt in about 5 years, and Wall Street seems to also be of the view that the company will experience several years of losses from this time forward.
Finally, I want to compare the stock to the freely available risk free rate. It’s all well and good to find a stock that’s trading at a relative discount, but unless the size of the discount is sufficiently large, the risk free investment still makes sense. Put another way, if an investor can earn a guaranteed return of 4.5% in a 10 Year Treasury Note at the moment, then a stock like this one must offer a premium of at least 3% in my opinion, or a 7.5% CAGR over the next decade to make buying at current levels reasonable. It’s certainly theoretically possible for the stock to get back to $12.75 (CAGR 7.5%), but I think the short term headwinds are too great to risk it at the moment. Thus, I think it makes more sense for investors to stick with “sleep at night” investments like Treasuries at the moment. Not only do these offer a level of predictability that no stock does, but they offer far superior risk adjusted returns to Redfin in my estimation.
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