Real estate, alternative real assets and other diversions

Rightmove’s shares could be good value if you don’t care about dividends

The Fund Manager

Rightmove is an incredible business. In the 11 years since it listed on the stock exchange its:

  • Revenues have gone up by more than 370%, going from £57 million to £268 million
  • Earnings have gone up by more than 1100%, going from 1.4p per share to 17.7p
  • Dividend has gone up by more than 980%, going from 0.6p per share to 6.5p

If that isn’t impressive then I don’t know what is.

And this isn’t the result of a one-off fluke, because Rightmove’s revenues, earnings and dividends per share have increased every single year for the last decade.

That, in a nutshell, is exactly the sort of broad and steady growth that so many of us are after, so Rightmove definitely deserves a closer look.

But like all investments, Rightmove has its bearish points as well as its bullish points, so in this blog post I run through what I think are the main ones before getting onto the subject of Rightmove’s measly dividend:

Bull point 1) Rightmove’s growth has been broad, steady and rapid for many years

All else being equal, its better to invest in high growth companies than low growth companies:

Rightmove’s growth has been impressively rapid and consistent

Here are some of Rightmove’s dazzling statistics:

  • 10-year revenue per share growth rate of 20% per year
  • 10-year earnings per share growth rate of 24% per year
  • 10-year dividend per share growth rate of 23% per year

And don’t think this rapid growth is simply a recovery from the dark days of the 2008/2009 credit crunch, because it isn’t. Other than a slight dip in revenues, Rightmove sailed right through the financial crisis as if it were nothing.

One thing I haven’t shown in the chart above is Rightmove’s capital employed growth. That’s because Rightmove has almost no capital assets (i.e. property, plant or equipment), so its capital employed growth rate is meaningless.

In this case, ‘almost no capital assets’ means about £11 million of office equipment, computer equipment and motor vehicles, but £11 million is peanuts for a company generating net profits north of £160 million per year, as Rightmove is.

The reason Rightmove can make so much profit from so little capital is that its main asset is its website, which is the UK’s most popular property portal. Even super-high traffic websites only require a few servers to run, and they cost very little compared to buildings, factories and other heavy capital infrastructure.

Actually, Rightmove’s main asset isn’t its website, although the website is the glue that holds everything together. Rightmove’s main assets are property buyers and sellers who use its website.

It works like this:

  • Property sellers (or landlords) advertise their properties on Rightmove because that’s where most of the buyers (or prospective tenants) are.
  • Property buyers (or renters) visit Rightmove because that’s where most of the properties are.

It’s a virtuous circle or positive feedback loop that’s also known as the network effect, and this network effect, combined with Rightmove’s position as the UK’s largest network of property buyers and sellers, is what drive’s the company’s success.

It’s a type of winner-takes-all economics and in some cases it can lead to profitability numbers that are off the scale.

Bull point 2) Rightmove’s profitability is through the roof.

Rightmove’s profitability is on another level

Here are some more of Rightmove’s amazing statistics:

  • 10-year average return on sales of 56%
  • 10-year average return on capital employed of 604%

Those numbers, especially the return on capital, are ridiculous. Normal companies just don’t produce returns of over 600% on shareholder and debtholder capital. But Rightmove does.

These returns are not the result of having the flashiest website, or the best engineers, or the most heroic CEO; they’re simply a function of Rightmove’s position as the go-to location for buyers and sellers of UK property.

And with extraordinarily high returns on capital, Rightmove can generate growth incredibly cheaply, without the need for expensive capital investments and acquisitions.

Bull point 3) Rightmove doesn’t need to invest in capital assets or acquisitions to grow

Some companies have to invest huge amounts of money today in order to build the infrastructure which will generate additional profits tomorrow.

Here’s a simple example:

You own a toll bridge which spans a wide, deep valley. The only way to cross the valley is by driving over the bridge, and thousands of people drive across the bridge every day on their way to work and back.

The costs of maintaining the bridge are negligible, and as the only bridge in town you can raise prices almost at will (although there are limits, beyond which your customers will either shoot you or find some way to not have to cross the bridge).

The bridge’s returns on sales are high because its operating expenses are low (the bridge is sturdily built and the toll booths are automated), and returns on capital are high because the bridge is old and the original value of the bridge has largely been depreciated away.

So your toll bridge is a good business, but there’s a snag.

There are limits to how many people can cross the bridge in a day and limits to how high you can raise prices. If traffic on the bridge is already maxed out, then a doubling of the local population won’t lead to a doubling of the traffic on your bridge (and therefore won’t lead to a doubling of revenues and profits).

To double your traffic capacity, you’d have to widen the bridge or build a new bridge, but both options involve massive upfront investment. Another option would be double capacity by acquiring a bridge over another valley somewhere else, but that would also require a huge upfront cash payment.

So while generating profits from the business is easy, growing those profits in a substantial way is very hard.

Fortunately, Rightmove’s business is nothing like that.

Unlike the toll bridge, if traffic to the Rightmove website doubles, all Rightmove has to do (more or less) is bolt on a few more servers to handle the extra traffic.

If traffic doubles again, Rightmove can just add a few more servers.

And relative to Rightmove’s £160 million profits, the £10 million or so it currently has invested in servers is almost laughably insignificant. Rightmove could easily afford to expand its servers ten-fold, but it doesn’t need to as there simply isn’t that much property related web traffic in the UK.

Capital expense is a miniscule percentage of profits

So unlike retailers who need to roll out new stores as they grow, or manufacturers who need to fit out new factories with machinery, or miners who need to dig new mines and fill them with trucks, diggers and other equipment, Rightmove can grow as much as the market will allow at virtually no cost.

And since Rightmove can grow rapidly without heavy capital investments or large acquisitions, the company also has no need to borrow money.

Bull point 4) Rightmove has no debt or pension liabilities

Debt is useful, but it’s also dangerous and is often a key driver of corporate collapse and demise (see Carillion or Interserve for examples).

Although I’ve been wary of highly indebted companies for years, I’ve become even more wary in recent months and at the start of 2019 I added a debt-to-profit ratio to my stock screen.

This tweak helps low debt companies like Rightmove move up the stock screens rankings, meaning they’re more likely to end up in my portfolio.

In this case, Rightmove hasn’t had any debt for years. It just doesn’t need it to produce spectacular results, so why take the risk?

And as an added bonus, the company doesn’t have the risk of a defined benefit pension either.

Rightmove is amazing, but it’s not all sunshine and rainbows

So far I’ve been unfailingly positive about Rightmove and that’s because it really is a spectacularly successful company with huge competitive advantages. However, there are risks and there are reasons to be bearish as well as bullish:

Bear point 1) Rightmove’s growth rate is slowing

Yes, Rightmove has grown by about 20% per year on average for more than a decade, but no, that growth cannot continue indefinitely.

Growth at all companies must slow as they approach the maximum size their markets can support, and Rightmove is no exception.






The Fund Manager, zLead Article, zNewsletter

About John Kingham

John Kingham

John Kingham is the editor of UK Value Investor, the investment newsletter for defensive value investors. With a professional background in software analysis, John's approach to high yield, low risk investing is based on the Benjamin Graham tradition of being systematic and fact-based, rather than speculative. John is also the author of The Defensive Value Investor: A Complete Step-By-Step Guide to Building a High Yield, Low Risk Share Portfolio. His website can be found at: www.ukvalueinvestor.com.

Articles by John Kingham

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