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Is Compass Stock a Buy After Its IPO?

Last year existing-home sales in the U.S. jumped 5.6%, according to the National Association of Realtors. Despite the pandemic, low mortgage rates sparked strong consumer demand, driving prices through the roof (no pun intended). And so far 2021 looks like another good year for the housing market.

With its initial public offering (IPO) last week, Compass (NYSE: COMP) became the latest player to enter the real estate fray as a public company. Its business benefits from a massive market opportunity, but it also faces tough competition. So is the stock a buy? Let's dive in.

The market opportunity

Compass focuses on empowering real estate agents rather than replacing them. The company's cloud-based software platform is designed to help agents build customer relationships, work more efficiently, and grow their businesses.

Image source: Getty Images

For instance, the Compass platform uses AI-powered analytics to surface lead ideas, helping agents identify potential buyers and sellers. This allows them to focus on high-value clients (e.g. clients that the platform identifies as "likely to sell"). In addition, the platform allows agents to create and launch marketing campaigns across channels like digital, social, email, and video. Agents can even use the platform to conduct virtual tours and livestream open houses.

Compass primarily generates revenue through brokerage commissions, though it offers title, escrow, and mortgage services as well. At the end of 2020 the company had a presence in 46 markets across the United States.

In total, management estimates the company's addressable market in the U.S. at $180 billion, representing a combination of commissions, closing services, and marketing services. Notably, the company puts its global market opportunity at $570 billion.

The competition

While Compass believes agents will continue to play a critical role in residential real estate, several key competitors see things differently.

For instance, rivals like Redfin and Zillow Group are trying to disrupt the industry with a novel approach: iBuying. Both of these companies buy houses directly and resell them through their own marketplaces. This eliminates the need for real estate agents, with the goal of simplifying the process for consumers.

Additionally, while Redfin also provides brokerage services, it employs its own agents and pays them salaries (rather than commissions). That allows Redfin to keep its commission fees 1%-2% lower than those of other brokerage firms, then pass those savings on to consumers. Compass doesn't offer this advantage.

Even so, Compass agents assisted in $152 billion in residential real estate transactions in 2020. That gives the company a 4% market share in the United States. By comparison, Redfin's brokerage service facilitated $37 billion in transactions, giving the company a 1% market share.

Moreover, 89% of home sellers and 88% of home buyers still use real estate agents -- and those numbers have changed very little over the last decade. From that perspective, Compass's business model has merit, and its size gives it an advantage.

Financial performance

Since 2018 Compass has delivered impressive top-line growth, easily outpacing rivals like Redfin and Zillow Group. As a result, its market share has quadrupled over that period.

Revenue

2018

2020

CAGR

Compass

$885 million

$3.7 billion

104%

Redfin

$487 million

$886 million

35%

Zillow

$1.3 billion

$3.3 billion

59%

Data source: Compass, Redfin, and Zillow Group SEC filings. CAGR = compound annual growth rate.

Despite growing its top line quickly, Compass's operating cash flow came in at -$58 million last year. In other words, the company is burning money. By comparison, Redfin and Zillow Group generated $61 million and $424 million in operating cash flow, respectively. That means both companies are more profitable than Compass.

The verdict

Investing in IPOs can be risky. In general, I think it's best to wait a few quarters before making the decision to buy. That gives the market time to digest any news, and it gives investors a chance to learn more about the company. Sometimes the public spotlight illuminates problems that weren't obvious prior to the IPO.

That being said, Compass has a big market opportunity and a relatively strong competitive position. If you want to pick up a few shares now, that should be fine. But wait for more information before building a larger position.

If Compass ends up being a long-term winner, waiting a few months won't be the end of the world. But if the IPO was mispriced or something else goes wrong, you could lose a lot of money by jumping in too soon.

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Trevor Jennewine owns shares of Redfin. The Motley Fool owns shares of and recommends Redfin, Zillow Group (A shares), and Zillow Group (C shares). The Motley Fool recommends the following options: short May 2021 $65.0 puts on Redfin. The Motley Fool has a disclosure policy.


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