I’ve been helping investors for over a decade, and a persistently difficult point to make involves earnings trades. Zoom (NASDAQ:ZM) stock fell almost 20% yesterday on its earnings headline.
For years I have struggled in convincing investors that the reaction to those headlines is completely binary overnight.
Of course, the results matter long-term, but the next morning open is almost entirely from emotions.
The proof lies with the giga-cap stocks like Apple (NASDAQ:AAPL) and Alphabet (NASDAQ:GOOGL,NASDAQ:GOOG). They haven’t delivered a bad earnings report in years. Yet the reactions are about 50-50 negative to positive. If it was all about the quality of the numbers, then earnings reaction would have been pop opens. They were not!
ZM stock fell yesterday more because of expectations than bad marks. The company grew revenues 35% versus last year. It also made decent improvements in profitability, and beat the estimates.
Somewhere inside all these good points the masses still found disappointments. I counted about nine price target downgrades, yet the average price target remains well above current. Therein lies the good news, because ZM stock has reverted back to a tradable base.
ZM Stock Opportunity Redux
Investors who thought they had missed rally before September now have a fresh chance. While this is a real opportunity, it’s important to know that it is not an all-clear sign. ZM stock buyers now will likely profit long term. However, all this pain happened while markets were breaking records. The S&P 500 set a new all-time high just two days ago.
This is overhang risk to all stocks that have fallen during that bullish stint. If we eventually get a correction, it will bring down all the great deals like the one in ZM today. Investing involves first picking the right company, and then finding appropriate entries.
Zoom’s report card is proof that they are executing on plans flawlessly. They took advantage of the pandemic usage spike and they are making it work.
A positive nuance in the earnings report suggests that they are efficiently building their clientele. There’s an old rule of thumb that says 20% of clients are responsible for 80% of sales. Zoom reported a 95% growth in clients who contribute more than $100,000 in sales. This means that their client-acquisition efforts will go a lot further and they will have less churn.
Strong Execution Made it Cheap
Management is showing good focus and strong execution. I have little doubt that they will continue to succeed over time. The habits that we developed last year are not going away. Online meeting spaces like Zoom make an incredible amount of sense. Reverting to old ways would be voluntarily undoing good things that came out of the pandemic.
I just don’t see that happening, therefore I would stick with the stock. The time to panic out has passed. But because of my earlier warning about the overall market risk, I would remain cautious now. Sizable drops like this one can take more than one day to unfold.
Valuation matters but not a lot in this case. Nevertheless, this is not an expensive stock anymore. It was incredibly rich last year, but thanks to the growth rate the metrics normalized. The price-to-sales went from $125 last year to just 20 today. Even the P/E is now two digits. This is cheaper than Tesla (NASDAQ:TSLA) and definitely in line with the sector.
This is a hard point to make, especially to value investors. However, the term “cheap” is relative. Zoom’s price-to-sales on IBM (NYSE:IBM) would be astronomically expensive. That’s because IBM shrinks, whereas Zoom is growing leaps and bounds.
The opportunity today in ZM stock lies in the nuances and the investor time frames. Those who have patience and a bit of logic will see it clear as day. And this is not the time to panic out of a quality stock like Zoom.
On the date of publication, Nicolas Chahine 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.
Nicolas Chahine is the managing director of SellSpreads.com.