It’s looking more and more like Zoom Video Communications (NASDAQ:ZM) has peaked out. I’m pegging the days following the end of the third quarter for reaching the zenith, as Zoom stock rose from $470.11 on Sept. 30 to a high of $568.34 on Oct. 19.
The problem is the stock has a super high valuation. This is especially so, now that the end is in sight for Covid-19 related restrictions with new vaccines rolling out.
For example, since its peak, Zoom stock fell more than 28% to $406.01, as of Dec. 18. Moreover, the shares are down 14.6% since the beginning of Q4. But let’s keep in mind that Zoom stock is up 497% year-to-date and 500% in the past 12 months.
Zoom Stock Valuation Issues
However, the problem is its forward price-to-earnings (P/E) valuation is too rich. It is over 136 times forward earnings.
Moreover, Yahoo! Finance has a similar earnings estimate from a survey taken by Refinitive of 27 analysts who cover Zoom stock. Their average earnings per share (EPS) estimate for the year ending January 2022 is $3.00. At $406.01 today (Dec. 18) the stock trades for 135x forward earnings.
However, that estimate is only 9 cents per share over the $2.91 estimate for FY 2021. That represents 3.0% annual growth, which is certainly not deserving of a 135 times valuation.
Moreover, the problem with this high level of valuation is that it is not just good enough to outperform expectations of earnings. Now analysts want to see a “magnitude” of outperformance that will justify the valuation.
For example, here is what the RBC Capital analyst Alex Zukin wrote in his report after the Q3 earnings came out:
“Zoom reported solid Q3 results that meaningfully outperformed guidance and consensus, though by a meaningfully lower magnitude, as the company now has a better grasp of underlying retention dynamics.
Competition Issues
However, the problem with this valuation level is that, as Investors Daily points out, Zoom has many competitors. Their article details all the rivals that Zoom is fighting against in both the business video communications side and also in consumer video.
In other words, Zoom does not by any means have a “moat” which protects its high valuation. And frankly, let’s be honest here. The main reason Zoom stock skyrocketed was because of the Covid-19 lockdown restrictions. This was a huge catalyst for the company and the stock.
However, Barron’s reports that J.P. Morgan analyst Sterling Auty told clients that it is now time to shift out of the Covid-19 tech plays like Zoom stock. In addition, Barron’s also writes that Cisco (NASDAQ:CSCO) is now trying harder to grab some of the consumer market share back with its Webex product.
What To Do With Zoom Stock
The highest earnings estimate I have found for Zoom stock is $3.59 a share for the year ending January 2023, listed as an average on Seeking Alpha’s analyst survey. However, that represents earnings that are three years in the future.
Therefore, we need to discount those earnings by at least 15% annually, to account for the present value of money and the implied opportunity cost. That works out to a discount factor of 65.75%. As a result, the present value of $3.59 EPS is worth $2.36 today.
This puts its P/E ratio at 172 (i.e., $406.01 divided by $2.36). This implies that Zoom stock is simply too high for most investors.
As a result, most investors should probably wait for the stock to tread water as its earnings rise. Alternatively, you could reasonably expect there will be a significant drop in the Zoom stock price.
Either way, now is not the time to take a new position in this richly valued stock, especially given the number of competitors it has.
In the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Mark Hake runs the Total Yield Value Guide which you can review here.
