There is nothing I love more than deep dips in high-quality companies. Despite the market’s big rally, Zoom Video (NASDAQ:ZM) and other high-quality businesses remain well off the highs. With ZM stock, this is an opportunity, not a warning sign.
Let’s back up a little bit first.
ZM stock went public in April 2019 and was met with a lot of optimism. The valuation was rich but not absurd.
Shares came into 2020 off the highs but holding up. Then the novel coronavirus pandemic sent the world into a frenzy. In the process, it sent Zoom shares rocketing. From the start of 2020 to its high on Oct. 19, ZM stock rallied 763%.
Currently, shares are down 35% from that high and at the recent low, the stock was down almost 44%. As nice as it is for every stock to go up forever, that’s not reality. From time to time though, we get these amazing pullbacks.
The 40% Discount
The 40% discount is not a fool-proof algorithm or some magic line in the sand. A high-quality stock may only fall 30%. It could dip 50%. It’s all dependent on what’s going on around it and what’s happening in the market.
Further, there could be years where a stock doesn’t fall by 30%, let alone 40%.
However, when we get a dip of this magnitude and the business is strong, the stock is worth a second look. While the stock price fluctuates wildly, the business tends to be more steady.
That’s what creates opportunities for long-term investors. When we see these 40% dips in names we really like, it gives us an opportunity to initiate a position for those that we missed the boat on – this is our ticket.
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Sometimes it’s a sharp recovery. Other times it’s a chance to accumulate over weeks or months.
Obviously it’s possible that Zoom stock falls significantly further than 40%. But largely speaking, a large portion of risk has been removed at this level and more likely than not, there tends to be more upside potential than downside risk.
Why Bulls Like ZM Stock: Growth
At $550-plus, ZM stock wasn’t a bad company, but it did have a high valuation. Near its highs, Zoom commanded a market capitalization just above $150 billion. At its recent low in January, it was just below $100 billion.
Current estimates call for $3.5 billion in revenue in 2021. At its current valuation – $110 billion – ZM stock trades at about 31 times revenue. That’s stretched, but not impossible to maintain or justify.
Particularly given the fact that, should Zoom deliver $3.5 billion in revenue in 2021, that would represent more than 35% growth from 2020, a year where revenue exploded more than 250%.
One would expect that after such a powerful year, a regular company would see a retreat in growth. At the very least, flat growth would be tolerated by many investors. But another year of 35% growth? Now that’s impressive.
So is the fact that analysts expect 24% growth in 2022, to $4.3 billion. That leaves ZM stock trading around 25 times 2022 estimates.
Admittedly, these are just estimates. There’s always the possibility that they are too aggressive. But there’s also a chance they’re too conservative. At the end of the day, I consider back-to-back years of 24%-plus growth to be wildly impressive following a year where revenue more than tripled.
The valuation here is big, but so is the opportunity. If Zoom keeps delivering, so will the stock.
With or Without Covid-19
When speaking with investors, most struggle with high-growth companies. The biggest issues tend to be valuation and profit. In other words, the valuations are too high for comfort and these companies tend to be unprofitable.
That’s not the case with Zoom, and it’s not just because of Covid-19.
Even before the pandemic started — even before Covid-19 was a thing — Zoom was profitable, cash flow positive and nicely growing revenue. For instance, revenue more than doubled from 2018 to 2019. Free cash flow more than doubled that year too, while Zoom turned in a profitable year.
Because Zoom was a strong company before the coronavirus, it stands to reason that it will remain a good company once the pandemic is behind us.
On the flip side, Covid-19 is a risk here. If employees go back to offices in droves and demand falls farther than expected for Zoom, then the stock is at risk. For now though, investors continue to believe in the bull case and in my opinion, rightfully so. It’s hard to imagine companies and users going to back slower, more expensive and less convenient options when Zoom is an excellent (and safer) alternative.
On the date of publication, Bret Kenwell did not hold (either directly or indirectly) any positions in the securities mentioned in this article.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell.
