Also like Peloton, Zoom’s brand name and market position strengthened tremendously during the Covid-19 pandemic, while its revenue gains have been quite impressive.
On the positive side for Zoom, the company is in a much better position than Peloton when it comes to barriers of entry and profitability.
Nonetheless, I believe that, given Zoom’s intense competition and the easing of the pandemic, the valuation of ZM stock remains excessive at this point.
During the pandemic, Zoom’s brand name became extremely strong. In fact, the company’s name, for most companies and consumers, became synonymous with videoconferencing. As FastCompany explained in May, Zoom became the ‘BandAid’ of pandemic life.
Not coincidentally, since the company’s brand name became so powerful, its revenue growth accelerated tremendously. In fact, Zoom’s top line jumped from $330.5 million in 2018 to $622.7 million in 2019 to $2.65 billion in 2020. This year, analysts, on average, expect its revenue to jump to $4.02 billion.
And without question, Zoom has become the leader of the videoconferencing sector. In June, ZDNet reported, “In the U.S., Zoom currently owns 60% of the online videoconferencing market share and rising. Globally, Zoom handles about 300 million daily meeting participants. ”
What’s more, Zoom is quite profitable; its operating income climbed from just $12.7 million in 2019 to $670 million in $670 million last year. And over the 12 months that ended in June, its operating income came in at $1.05 billion.
Some say that videoconferencing has low barriers to entry as competitors can easily enter the space. I believe, however, that launching a high-quality videoconferencing tool is not very easy, given the technical requirements of such a product, including the need to provide decent security for it. Indeed, in the past, Zoom put a great deal of effort into its security features.
So compared to telemedicine or connected exercise bikes, videoconferencing, has relatively high barriers of entry.
But on the other hand, Zoom is competing with a number of huge tech companies. Among the large firms offering videoconferencing are Microsoft (NASDAQ:MSFT) through its Teams software, Cisco (NASDAQ:CSCO) through its WebEx subsidiary, and Salesforce (NYSE:CRM) through Slack, which it acquired earlier this year.
These two challenges likely played key roles in causing the company’s recently issued unimpressive third-quarter guidance. Specifically, Zoom predicted that its Q3 revenue would be little changed versus Q2 and roughly in line with analysts’ average outlook. Moreover, it provided Q3 earnings per share guidance of $1.07 to $1.08, slightly below analysts’ meant outlook at the time of $1.09.
Meanwhile, Seeking Alpha columnist Brian Kapp noted that the company’s operating income margin only inched up 0.49% in Q2 versus Q1. Conversely, that metric jumped 5% in the first half of this year versus the second half of last year. The data suggests that the company’s profitability hit a ceiling in Q1, Kapp stated. ZM stock tumbled sharply in the wake of the company’s guidance.
And a number of Wall Street analysts cut their price targets on the shares following the publication of the company’s Q2 earnings. KeyBanc’s Steve Enders trimmed his price target on the name to $398 from $428 while keeping an “overweight” rating on the shares, FBN’s Shebly Seyrafi slashed his price target by $125 to $400, and Deutsche Bank’s Matthew Nikam lowered his price outlook $25 to $350 while maintaining a “hold” rating.
Valuation and the Bottom Line on ZM Stock
The shares are changing hands for 55x analysts’ average EPS estimate for this year. While that’s not a huge valuation, it is somewhat steep, given the tough challenges that Zoom is facing. Further, analysts, on average, do not expect the company’s EPS to rise significantly next year, compared with this year. Its lack of expected EPS growth next year is another factor that makes the shares too expensive.
In light of these points, I recommend that investors sell the shares and wait for a better entry point and/or clarification on the company’s ability to overcome its challenges before considering taking a bullish position in them.
On the date of publication, Larry Ramer did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.