My goal today is to make sure investors know why and how to chase the rocket ride known as Zoom Video (NASDAQ:ZM). Zoom’s giant rally makes it tricky to trade and could cause a lot of grief without proper optics. I will sound a little bearish on some aspects of ZM stock today, but my objective is to find two ways to profit from its upside.
Being a momentum stock makes Zoom an excellent trading vehicle, but a dangerous investment asset. I respect what the company has accomplished in such a short period of time.
The action in ZM stock is proof positive that this is a legitimate opportunity for the long-term. But it is important to properly define the opportunity first. In short, investors should wait before taking a position while traders can chase the impending breakout into a new high.
2020 has been the strangest year for investing that I have ever seen. First we set a new high, then we get a global shutdown that caused a complete market collapse. Then out of the ashes the indices came roaring back in record time to set new highs. The NASDAQ did it in June and the S&P 500 finally did it yesterday.
Meanwhile, the quarantine was a financial disaster for most businesses, but there were a few sectors that exploded in popularity. Zoom is perhaps the poster child for the lucky few Covid-19 stocks. Case in point: ZM stock rallied 300% in a matter of weeks.
Chase the ZM Stock $35 Breakout Opportunity
This stock was the exception to the rule because it never corrected. When the equity markets collapsed in February, ZM stock broke out to start its monster rally immediately. It stalled in July and since then the bulls and bears have been in a range-bound tug of war which the bulls seem to be winning again.
If the buyers can take the stock above $280 per share they can rally at least another $35 from there. This is a purely technical assessment of the price action and has nothing to do with my opinion the stock. Next is where I risk upsetting the fans.
Fundamentally, I have issues with what the buyers up here are chasing. But first let me properly frame my opinion by saying that I believe in growth stocks carrying high valuations. It is an absolute necessity because they need to spend a lot to grow a lot. In this case, it goes too far from the perspective of expectations. ZM stock rallied on news of an explosion in user metrics. I have no doubt that almost every person on the planet that has an internet connection has used this service. However, this is not the same as saying that the users will turn into an income stream.
Most of the people I know will not pay for the service because there are so many free alternatives. These users are a drain on resources more so than an opportunity for profit. Some of these competitors are huge and include formidable opponents like Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG) to name one.
When I launch my Gmail app on my phone I see two prominent buttons, and one of them is “Meet.” That’s the button I would push if I need to use a video service. I also hold weekly live charting sessions for hundreds of people and I do not use Zoom for that either.
Valuation Problem Comes from Lofty Sales Expectations
I acknowledge that they have a very healthy business outlook, but I have issues with the sales premium that the investors are allowing here. There is too much hope baked into the stock and that makes for a very high bar.
Zoom’s price-to-sales is a whopping 108 times. This means that those who buy it today are fronting the company 108 years worth of sales for the privilege of owning it. Unless they have found the fountain of youth, they are likely going to face disappointment.
For absolute comparison let’s consider Amazon (NASDAQ:AMZN), which is an expensive stock yet has a price-to-sales of 5.7x, which is 19 times cheaper. Amazon is not a direct competitor but is also a growth stock still growing over 40% per year with a ton of profits.
Buy the Dip, Chase the Breakout, or Create Profits from Nothing
For a trade, ZM stock looks poised to breakout if they set a new high. Momentum buyers will then chase it under the plan of buying-high-and-selling-higher. But from an investment perspective, it is more prudent to snipe a more reasonable entry point after a dip. I would rather wait to buy it after a dip near $220 or even down to $180 per share. I know this seems impossible at the moment, but if you think about it, it was there just two months ago.
Ignore the ruckus of the mega bulls or bears and consult the charts for clues. If I need to get bullish into its earnings report I’d sell the October 2 put and collect almost $4. I won’t need a rally to win and I won’t lose money unless ZM stock falls below $196 per share. This would mean that I am getting paid for the opportunity of buying shares at a 28% discount, else I create profits out of thin air.
Nicolas Chahine is the managing director of SellSpreads.com. Join his live chat room for free here. As of this writing, he did not hold a position in any of the aforementioned securities.
