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Zoom Is One Of The Most Overvalued Stocks I’ve Ever Seen

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There’s a famous investing saying that says you should invest in what you know.

I agree with this to a degree… You should understand the business well before you invest in something.

But you shouldn’t invest in something just because you use its products or services.

This is especially true in the tech arena.

For years now I’ve done all my business and work virtually.

I love, admire, and use on an almost daily basis technology to run things.

This means I know the industry well. But I rarely invest in new tech companies because of their often absurdly high valuations.

Case in point is today’s stock Zoom Video Communications.

Intro To Zoom

Because I run my businesses online and do trainings with students and clients worldwide, I need a reliable video conferencing platform.

Years ago there was only one choice with Skype.

It was “okay” but was often slow. And is banned from use in many countries worldwide.

Because of these things I was always on the lookout for new video conferencing technology to use. And then after looking for a while I found Zoom to replace Skype.

I loved it and have used it ever since… And now use it on an almost daily basis to meet with clients, students, and my team.

I love the software and am intimately familiar with it… But there’s zero chance I’m going to invest in it any time soon due to its enormous valuation.

Before I get to that though I need to show you how much its grown this year as the coronavirus pandemic launched Zoom stock into the stratosphere.

Zoom Shares Are Up 292.2% This Year

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From January 1st to today Zoom shares rose 292.2% in a little over 6 months.

This is an enormous increase in a short period that is almost 100% attributed to the increase from people needing to work and attend school from home due to the coronavirus.

If you invested $10,000 in Zoom shares on January 1st, 2020 until today that investment would now be worth $29,220 in less than 7 months.

This is an annualized return of 567.3%.

You’re investing well if your annual returns are 10%+ per year on a consistent basis so this is amazing.

But it’s also unsustainable.

Zoom revenue exploded from $61 million in 2017 to $829 million in the last 12 months. But this huge growth caught the attention of gigantic competition.

Since Zoom’s rise in March, Facebook, Microsoft, and Google have all announced either new or massively increased video conferencing software offerings.

Combined these companies are worth north of $3.36 trillion as of this writing.

Zoom’s market cap is $77.6 billion.

This means Facebook, Microsoft, and Google all have a huge advantage in terms of resources to work to crush Zoom.

Will they?

I have no idea. And personally, I hope not because I still prefer Zoom to these other offerings.

Another reason this isn’t sustainable is because while Zoom’s revenue skyrockets its profits aren’t keeping up.

Zoom IS Profitable

Most tech startups are unprofitable for years. But Zoom isn’t one of these companies.

Its profitable already.

But it may not be earning enough profits and cash flows to withstand the onslaught from its competitors.

On an operating profit basis Zoom’s produced an average operating profit margin of 0.2% per year on average every year of the last 3 years. And in the trailing twelve months its upped this to 4.2%.

Normally I look for 10 years data here and prefer at least 5. But Zoom went public in 2017 and its data only goes back in terms of profits to 2018.

I look for any company to produce above 10% margins on a consistent basis to consider as an investment.

Zoom’s margin though improved, falls well below my threshold of what I look for to consider for investment.

What about FCF/Sales?

Over the last 4 years its averaged 9.6% per year. FCF/Sales goes back to 2017. And in the trailing twelve months this number skyrocketed to 42.2%.

I look for any company to produce above 5% margins on a consistent basis to consider as an investment.

Zoom’s average FCF/Sales is above my minimum threshold… And in the last 12 months it crushes this number. But will this continue with the increased competition?

That’s impossible to say for now but I can guarantee this number will fall from 42.2% going forward.

Not just due to the competition but almost no companies on Earth earn regular FCF/Sales margins of 42.2%.

Even though I expect its FCF/sales margin to fall, I expect it to stay above my minimum threshold of 5% per year due to the nature of its business model.

Both operating profits and free cash flow are important because they help show you the profitability of the company.

The more profitable a company is the higher its value goes over time. And the more money it can spend on innovations and serving customers.

Increasing profits and cash flows also drive valuations higher… But not when people in the market continue buying your shares and driving the price higher than profits are growing.

This is the main reason I’m not buying Zoom stock even though I love its software… Its massively overvalued.

Zoom Is One of The Most Overvalued Companies I’ve Ever Seen

As a conservative investor I want to recommend solid, safe, and relatively low risk investments to you.

Often those are achieved by high profit margins and low debt. But its also necessary to look at valuation too.

Because if you buy overvalued assets there is a lower margin of safety. Which means the investment is riskier.

I want to buy assets that are undervalued in a best-case scenario. And at worst fairly valued.

Unfortunately Zoom falls into the overvalued category…

Its current P/E ratio is 1,510.

It’s current P/CF is 204.

And its current forward P/E is 213.

These numbers are sky high.

I look for companies to sell at ratios below 20 to consider the investment undervalued based on these metrics.

According to its current valuation its massively overvalued. And one of the most overvalued stocks I’ve seen in my 13+ year career.

This is due to people buying its shares and speculating it will continue its rise higher now that more people are forced to work and attend school virtually.

I don’t recommend stocks based on speculation… Even if I love the company products and services.

Does this mean I expect Zoom stock to crash in time? No.

But because of its sky-high valuation its far likelier to crash than it is to rise by another 300% any time soon.

Personally, I hope it keeps performing well and growing its user base and functionality.

As a daily user of its software I want this to continue. But this is speculation.

And I don’t speculate when I buy for myself or the portfolios I manage. Or when I recommend anything to you.

The saying “invest in what you know” makes sense to a degree.

But you need to know when you need to break that rule too.

For now, stay away from Zoom’s stock.

If you’re looking for some potential stocks to consider buying use the following links to some of our recent articles.

The Best Internet of Things Stock

The Best Telehealth Stock To Buy

3 NASDAQ Stocks To Consider Buying Part 1

3 NASDAQ Stocks To Consider Buying Part 2

3 NASDAQ Stocks To Consider Buying Part 3

 

Disclosure – Jason Rivera is a 13+ year veteran value investor who now spends much of his time helping other investors earn higher than average investment returns safely. He does not have any holdings in any securities mentioned above and the article expresses his own opinions. He has no business relationship with any company mentioned above.

 

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