I don’t think anyone knows their exact algorithm but it combines sales data, assessment data, asking prices (yes, they use asking prices) and economic data. Their estimates can also be manipulated by adding or subtracting upgrades.
If you click through a bit, you can find their accuracy charts — which lets you know that they are +/- 10% on a good day. But the bottom line is that Zillow and all of the others all arrive a different values. I say that clients should use these estimates IN their analysis, but not AS their analysis.