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Zoom Is the Perfect Stock for This Market

The broader battle over the market's valuation is embodied by ZM stock

Zoom Video Communications (NASDAQ:ZM), which recently launched an IPO of its stock, seems like the perfect reflection of the broader battle over equity valuations. Investors who are skeptical of this stock market which has reached all-time highs will see ZM stock as the pinnacle of absurdity. On the other hand, those who see stocks in general and tech stocks in particular going higher will rave about the opportunity offered by Zoom stock.

Zoom Is A Great Company, But Post-IPO Pop Valuation Looks FullBoth sides can make a strong case.The valuation of ZM stock does look close to obscene. But the company’s capabilities in videoconferencing – a technology that literally could change the world – suggest that it has a massive addressable market.

For some time, then, it seems likely that market sentiment will move Zoom stock. ZM stock will be the ultimate trade on the “risk-on” versus “risk-off” attitude that has defined market trading over the past few years.

Is Tech Overvalued?

There’s no shortage of investors who see U.S. equities in general, and tech in particular, as overvalued. The same risks that led stocks to tumble in December still exist, yet equity markets have risen above their previous levels. Unprofitable or barely profitable software companies trade at massive valuations. For instance,  Shopify (NYSE:SHOP) trades at 20 times its revenue and 250 times next year’s consensus earnings per share estimate. As impressive as that company’s opportunity is, at some point valuations have to matter, as I wrote earlier this month.

The same can be said of other high-flyers like Workday (NASDAQ:WDAY), MongoDB (NASDAQ:MDB), or Twilio (NYSE:TWLO). Their opportunities for growth are enormous. But that was true for Internet stocks , and it took even (NASDAQ:AMZN) years to reclaim its dot-com bubble peaks. Microsoft (NASDAQ:MSFT) didn’t reclaim its highs for well over a decade. Cisco Systems (NASDAQ:CSCO) dominates the networking space, and it’s still below its 2000 highs.

And those are the winners. Many losers have long since gone bankrupt or lost huge chunks of their peak valuations.

ZM Stock Is the Most Expensive Name in the Market

What’s perhaps amazing about ZM stock is that even in this market, it looks like the most expensive stock out there. Per its most recent S-1, there are some 269 million diluted shares of Zoom stock  outstanding. That suggests a market capitalization for ZM stock of nearly $18 billion. Yet Zoom generated just $330 million in revenue in its fiscal 2019 which ended on Jan 31. That’s a price-sales multiple of 55.

That’s an enormous price-sales multiple. MDB, which has also sparked valuation concerns, has a price-sales ratio of under 30. Zoom’s sales are growing quickly, as they more than doubled in FY19. But assume they rise another 100% in FY20. ZM stock would still trades at something like 27 times its sales. And it’s not as if other high-flyers aren’t growing rapidly.

To many investors, 55 times revenue on its face is simply absurd. It’s a multiple that makes Zoom stock untouchable. Zoom is modestly profitable. But the amount of growth priced in at its current level almost by definition suggests that investors are expecting perfection.

And, at the least, it seems like a multiple that cannot be supported if the bull market ends. If investors start fleeing risk – as they did at the end of last year – Zoom stock would seemingly be one of the first to plunge.

Is There a Case for ZM Stock?

All that said, as prohibitive as the valuation of Zoom stock appears to be, investors might not want to dismiss ZM stock so quickly. An $18 billion valuation might seem ridiculous against $330 million in sales. But ZM has a real opportunity.

Zoom’s videoconferencing platform, and the pending introduction of its Zoom Phone, create an enormous addressable market. The S-1 estimates that market at $43.1 billion in 2022. Software-as-a service communications providers RingCentral (NYSE:RNG) and 8×8 (NYSE:EGHT) combined are worth over $10 billion alone.

Both companies trade at much lower valuations: 8×8, in fact, has modestly higher revenue than ZM and a valuation of just $2.25 billion. But if Zoom can transform videoconferencing and take share in the UCaaS (unified communications as a service) market, it will have the opportunity to generate billions of dollars of revenue annually.

Meanwhile, its profit margins should be enormous if that scenario materializes. Its subscription revenue should be sticky. If Zoom can take 20% of its market, which would equate to- some $8 billion of revenue and generate 30% EBITDA margins, it could easily be worth $50 billion. That process would likely takes a decade, at least,  but a stock that triples over ten years provides a solid, annualized return of 12%.

Skeptics might say that  ZM would need to grow at an enormous  annualized rate of 38% for that scenario to unfold. Many of the conditions that would have to happen for Zoom stock to reach that valuation may not occur. In that context, 12% returns for a bet on a bullish scenario might not seem worth it.

Watch the Market

But the point right now is that the numbers can work. And for now, that’s all that really matters. SHOP stock looked overvalued to many at half its current price. Pretty much any trader who has tried to short SaaS stocks on valuation in the last few years has been run over. In contrast, those who have paid attention to the companies’ opportunities, and not to their multiples, have been handsomely rewarded.

But  market skeptics say valuations can’t just keep moving higher forever. And ZM stock, trading at a multiple double that of “expensive” stocks just days after its IPO, will be the proverbial canary in the coal mine.

Perhaps. But what the market has shown in 2019, and indeed for the last few years, is that a stock with the potential to transform and dominate its industry is going to find buyers. Even in the ugly market of Q4, SaaS stocks actually did well: WDAY, MDB, and TWLO all rose in that quarter. At some point, valuations may just get too high. Until then, however, there’s no reason Zoom stock can’t move even higher.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media,

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