The Risk/Reward for Opendoor Stock Is Amazing – The Motley Fool

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I’m an owner of Opendoor (OPEN -4.12%) stock, but I’m not 100% convinced that this company will succeed. To me it’s an open question (or an OPEN question, if you like stock ticker puns). There’s a  real chance that the company might need Chapter 11 protection at some point, because its business model requires a huge amount of debt.
On the other hand, there’s also a significant possibility that Opendoor will succeed. Opendoor is using artificial intelligence (AI) to help it value houses and make a market. The company is a pioneer of the iBuyer model, which promises to make homebuying quick and painless.
Should investors buy shares in such a risky company? I think so. Here’s why.
Image source: Getty Images.
According to The Wall Street Journal, Americans borrowed $1.6 trillion to buy houses last year. Opendoor is an active participant in that massive market, buying and selling houses using AI technology and algorithmic data. As its AI solution gets more data, Opendoor expands and is able to take a larger slice of the housing pie.
What’s especially scary for the rest of the traditional real estate market is the network effect. As more and more houses are listed by Opendoor, it becomes the place where everybody goes to shop for houses.
This prospect terrified existing players, and they felt the need to jump in. Zillow (Z -1.82%), for instance, has long been in the business of using software to give people an estimate of the value of their homes. When Zillow saw the rise of Opendoor and the iBuyer phenomenon, it responded by direct competition. Zillow used its software estimates to start buying and selling homes, too. 
But Zillow found out the hard way that its valuation software wasn’t all that accurate. To be more specific: Zillow had a lot of trouble predicting future price trends. If a family wanted to know what their house was worth at the present moment, Zillow’s algorithm could give them a solid answer. But predicting future prices is tricker, as the housing market can zig and zag, with valuations changing over time.
In short, Zillow overpaid for a lot of houses and the company had to put a halt on its buying operations. It then canceled its iBuying division altogether. It was a very public failure, and the Zillow stock chart now looks like Mount Everest. 
Z data by YCharts
Unlike Zillow, Opendoor has no other business model to fall back on and is thus all-in on the iBuying concept. It’s the first mover in this space, and now that Zillow has run away, Opendoor is the top dog as well. That’s the first (and most important) criterion for a Motley Fool Rule Breaker: Top dog and first mover in an important, emerging industry.
Zillow’s problems ultimately came down to a faulty algorithm. AI is only as good as the data the machine is given. Opendoor, which has been risking money from the beginning, has accumulated impressive housing data. And its first-mover status has given it a big headstart in machine learning. 
Opendoor starts with real estate data from the MLS (multiple listing service) and tax assessor databases. Within its markets, Opendoor has inspected and analyzed approximately 375,000 houses. With each house, the company collects over 100 data points. This includes things like power line proximity and road noise level. Opendoor estimates that it has made 1.4 billion annotations and adjustments to the basic housing data that anybody can find.
Using this data, the company’s AI solution continually makes adjustments to its pricing algorithms. Opendoor uses machine learning to create models for home sale prices and forecast future demand. Its computers look for signals that a house might be an outlier, performs overall risk assessment, and manages its housing inventory.
The big question is whether Opendoor’s AI can solve the market forecasting issues that forced Zillow to quit. 
I think there’s a pretty good chance that computers will be able to predict movements in the housing market. One way to think about AI investments is to consider how many variables there are and whether it’s even possible to accumulate enough data for the computer to predict future events. Opendoor’s AI solution seems to be tackling a far easier problem than what Tesla (TSLA 0.58%) is chasing, for instance. 
Regardless, my investment thesis is that the Opendoor reward is so incredibly high that it’s worth a small investment now, even with a significant risk of 100% loss of capital. Imagine a coin flip with 50-50 odds, but with an unbalanced payout. You risk $1,000 on the coin coming up heads. If it comes up tails, you lose the $1,000. But if it comes up heads, you win $100,000. That’s how I see Opendoor right now. If we’re right, the upside is significant. This company could be the Amazon (AMZN -0.88%) of real estate — with the network effect providing an incredible moat. 
I don’t know the exact odds of success, of course. They’re not 50-50. They might be 60-40, or 10-90. But you don’t need to be certain to appreciate the risk/reward. I’ve made a small investment here (under 1% of my investing assets) because the upside is so large if we are in the right. 

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