Could Rate Cuts Help Send Opendoor's Stock Soaring?

Key Points

• The Fed cut rates last week for the first time in months.

• Rate cuts could entice retail investors to take on more risk.

• Low interest rates, however, may not solve the problems around Opendoor's business.

• 10 stocks we like better than Opendoor Technologies ›

Opendoor Technologies (NASDAQ: OPEN) has been one of the top-performing stocks on the market this year, rising by a staggering 500% thus far. Recently, it has taken a break from its high-powered rally and is showing signs that investors are perhaps growing a bit more cautious about its valuation, or simply cashing out some sizable profits.

But if interest rates continue trending lower in the months ahead, could that lead to another big rally?

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Here's a look at what could happen with interest rates in the near future, and what effect further reductions may have on Opendoor's stock.

Image source: Getty Images.

Why rate cuts may be good news for Opendoor's stock

Last week, the Federal Reserve announced interest rate cuts for the first time in months. It wasn't a big surprise, as recent economic data has been underwhelming and there was growing support for a reduction in interest rates. And there's a possibility that more rate cuts could be on the horizon.

According to the CME FedWatch tool, there's a 92% probability that the Fed will cut rates in October, and a roughly 80% chance that they will be cut again in December, pushing the target rate to between 3.50% and 3.75% before the end of the year.

For speculative meme stocks like Opendoor, declining interest rates can be a positive catalyst for multiple reasons.

The first is that at lower interest rates, it becomes cheaper to borrow money, which can be significant for a business that's looking to grow and also burning through cash. Thus, it makes stocks less risky.

Secondly, low interest rates can entice investors to focus more on stocks rather than other investments that provide lower yields. Retail investors anticipating such trends may end up taking on greater positions in meme stocks like Opendoor.

But that doesn't mean that investors should ignore the company's poor fundamentals.

Why lower interest rates may not be enough to help turn Opendoor's business around

Lower interest rates could result in more buying in the real estate market. If it's easier to obtain a mortgage, that can lead to greater business for Opendoor, whose iBuying strategy means it's buying and selling properties, hoping to flip them at a profit.

But there are still a couple of problems to consider. The first is that while interest rates may be lower, that may not necessarily result in a huge uptick in demand. While a mortgage may be lower, if food costs and other expenses have risen significantly due to tariffs and challenging macroeconomic conditions, buying a house may still not be all that affordable.

Plus, taking on a mortgage is a big long-term commitment, and at a time when there is so much uncertainty in the economy and concern about job losses, it's by no means a guarantee that lower interest rates will result in a significantly stronger housing market.

Secondly, and more importantly, is that more volume for Opendoor doesn't guarantee the company's bottom line will be in far better shape. Opendoor generates a shockingly low gross profit margin. Through the first half of this year, its gross profit totaled just $227 million on revenue of $2.7 billion. At a rate of only 8%, that means that of every $1 in revenue, $0.92 are going to cover the company's cost of sales. What's left over has to cover its overhead, including sales and marketing, general admin, and tech costs. Unsurprisingly, the company remains unprofitable, with its net loss over the past two quarters totaling $114 million.

Rate cuts aren't a reason to invest in Opendoor's stock

Opendoor's stock didn't take off after the Fed cut rates last week, but that's also because it was a widely expected move. But if the longer-term view is that interest rates will continue going lower, that could entice retail investors to be bolder with their positions in Opendoor, prompting a greater rally.

While that may be a tempting reason to speculate on the stock, there isn't a solid reason to invest in the company for the long term, given its poor margins and lack of profitability. Until the business drastically cuts costs and can improve upon its bottom line, you'll likely be better off avoiding the stock.

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David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.