Zoom Video Communications (NASDAQ:ZM) was one of the market’s favorite stocks during 2020 and the start of the pandemic. “Zooming” became commonplace, and the company saw a staggering acceleration in growth throughout 2020 that pushed the stock price to almost $600 per share.
Now the pendulum on the stock has swung in the opposite direction. Investors seemingly want nothing to do with Zoom, and the stock is down more than 70% from its October 2020 peak. Is the stock doomed? Or will this falling knife again find an upward trajectory? Here is what you need to know.
Zoom’s elevated stock price was unsustainable
Both users and investors flocked to Zoom in 2020. With lockdowns in full force, people “Zoomed” with friends and family, students Zoomed for school, and businesses Zoomed with clients. The world definitely took on a digital focus. For Zoom, it meant that revenue shot up 326% in fiscal 2021 (which hues close to the 2020 calendar year) to $2.65 billion.
Despite this blistering revenue growth, the stock price somehow outran it. The stock’s price-to-sales ratio shot as high as 120, making Zoom one of the most expensive stocks on the market at the time.
It only makes sense that as pandemic lockdowns eased and Zoom’s temporary surge in growth faded, investors would begin to cool on the stock. The stock price decline has been steep, possibly pushed lower by a broader market sell-off among growth stocks in 2021.
Zoom Video’s fundamentals remain intact
But just because Zoom couldn’t maintain its triple-digit growth rate, it doesn’t mean the company isn’t still thriving. In the third quarter of fiscal 2022 (ending Oct. 31, 2021), Zoom reported $1.05 billion in revenue, a 35% increase year over year. Its full-year 2022 revenue guidance of $4 billion would mean 51% growth compared to fiscal 2021. That means Zoom managed to grow 51% on top of that crazy 2020 calendar year when the business exploded.
Zoom’s net dollar expansion rate in Q3 was above 130% for the 14th consecutive quarter, meaning that Zoom’s existing customers are spending more once they begin using its products. Zoom Phone, which is the company’s new unified communications app, is helping drive this spending. Management reported in Q3 2022 that Zoom Phone saw triple-digit percentage revenue growth year over year.
A growing company like Zoom is often unprofitable, but Zoom has strong financials already. Management is expecting non-GAAP earnings per share (EPS) of $4.85 for the entire 2022 year, a nearly 300% increase over the prior year. This shows that Zoom’s profitability is accelerating as revenue is now outrunning the company’s costs.
From nosebleed expensive to bargain-basement
The stock market can be irrational and stock traders are prone to overreact to things. Zoom’s stock was definitely overpriced at its peak, but the momentum has swung so far the other way that the stock is now arguably a bargain.
The stock price has now fallen to pre-COVID valuation levels, despite the business’s continued growth. Its price-to-earnings ratio of 34 is less than that of a consumer goods company like Nike, despite growing EPS at a triple-digit percentage rate.
Meanwhile, if you look at the price-to-sales ratio to value the stock by its revenue, it’s a fraction of a company like Cloudflare‘s P/S of 38, while having roughly the same revenue growth. It’s becoming harder to ignore Zoom based on the current valuation and substantial numbers it’s put up.
A risk to keep your eye on
If there is a worry for investors, it’s probably competition with Microsoft. Microsoft is much larger than Zoom, making it a formidable competitor with deep pockets. Zoom, of course, competes with Microsoft Teams, which is a crucial cog in Microsoft’s grip on the enterprise market.
Investors will want to monitor Zoom’s revenue growth and management’s comments on customer account growth to ensure that Zoom competes well. I think that there’s room for more than one winner in such a large market, but if Zoom starts losing so much business that its growth begins declining, investors might reconsider their stance on the stock.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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