1 More Reason To Avoid Zoom
Two months ago I showed you several reasons why you should avoid Zoom As Its One Of The Most Overvalued Stocks I’ve Ever Seen.
Today I tell you 1 More Reason To Avoid Zoom Stock. Even after it reported blowout earnings.
You can read the full article above.
But if you don’t want to; here’s a quick recap of why I said you should avoid Zoom.
Zoom Shares Are Up 292.2% This Year
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.
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.
This thesis of Zoom continuing to perform well was proved out on August 31st when it released its most up to date financial info.
- Revenue grew 355% to $663.5 million in the 2nd quarter of 2020 compared to $198.1 million in the 2nd quarter of 2019.
- Net income rose 3,281% to $186 million in the 2nd quarter of 2020 compared to $5.5 million in the 2nd quarter of 2019.
- It produced more net income in the last 3 months than it did in the entire year before that.
- And Zoom averaged 148.4 million monthly active users in the quarter which is up 4,700% from the 2nd quarter of 2019.
These results led Zoom shares to rise 41% in afterhours trading which added another $37 billion to the company’s market cap.
This is equivalent to adding a company the value of eBay to the value of Zoom.
So far, this year Zoom shares are now up 508% from $68.72 per share on January 2nd, 2020 to $417.57 per share as of this writing.
These results aren’t simply good… They’re spectacular.
So why am I still recommending you avoid Zoom stock even though I love it personally… And its producing stellar results.
Because it’s still massively overvalued…
Its P/E is 76.8.
Its P/CF is 84.2.
And its forward P/E is 31.6.
I look to invest in stocks that are below 20 on all these metrics to consider the investment undervalued.
And this means investing in its stock today gives you no margin of safety in investing terminology.
When you invest in stocks that have a margin of safety it makes the investment safer. And it also means you should expect to earn higher returns owning its stock in the coming years.
The inverse of this is also true…
When you invest in a stock without a margin of safety it makes the investment riskier. And it also means you should expect to earn less owning its stock going forward.
This lack of a margin of safety is the category Zoom falls into right now.
Its valuations came down so much from 2 months ago when I wrote to avoid Zoom because of its huge increase in profits and cash flow… But even with this enormous increase in profits and cash flow the company is still massively overvalued.
This illustrates why you should avoid companies with huge overvaluations… Because just to keep the stock price up they must continue performing spectacularly well.
Will Zoom continue to do this over time?
Personally, I hope so because I love its software and use it every day. And due to more people continuing to work from home good results should continue.
But I don’t recommend you buy stocks based on shoulds or even companies you love personally.
Because over time companies don’t perform spectacularly every single quarter…
It could be next quarter, or it could be 5 years from now… I have no idea.
But I do know that companies can’t perform spectacularly forever.
And I also know that I don’t want companies I recommend you invest in have to continue to perform spectacularly to keep moving forward because this isn’t realistic to expect.
Especially with more and more competition from Google, Microsoft, Facebook, and others coming out and getting better every day.
For this reason of its still enormous valuation I recommend you continue avoiding Zoom stock.
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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.