Please ensure Javascript is enabled for purposes of website accessibility

Zoom Video Communications: Great Company, Terrible Stock

By Brian Stoffel - Updated Apr 26, 2019 at 10:56AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

An 18-bagger in less than two years? Here's how.

Just 16 months ago, Zoom Video (ZM 5.61%) was valued at $1 billion. When trading ended on April 23 of this year, that valuation had increased 18-fold! It was closing in on $20 billion!

Let's put that into perspective. Zoom is a recent IPO. If it had been public the whole time, that would equate to the stock increasing 20% every month. And here's the real kicker: This isn't just market insanity. Zoom is a high-quality company. How high quality? Let's investigate.

Suited man in bathtub throwing money into the air.

Image source: Getty Images.

As an investor, I almost never quibble about valuation when three things are present: financial fortitude, management with skin in the game, and a business that combines optionality (I'll explain what that means below) with a wide moat.

Financial fortitude

After raising money in its IPO, Zoom is on solid financial footing. The company could have as much as $524 million in cash and investments after the offering versus absolutely no long-term debt.

Additionally, the company actually brought in $23 million in free cash flow last year. That's not usually the case with smaller, fast-growing, software-as-a-service (SaaS) companies.

Both of these facts -- a sizable war chest and positive cash flows -- mean Zoom has lots of flexibility. Should an economic downturn occur, it would be on solid financial footing. And no matter the economic climate, it has flexibility to take advantage of opportunities when they arise.

Skin in the game

I love investing in founder-led companies -- especially when management has lots of skin in the game and a workforce that raves about their employer.

Founders often view their companies as representations of their life's work, and they are intrinsically motivated to build something of lasting value. When their management team is also financially motivated via share ownership to create value, that doesn't hurt.

On all three of these points, Zoom qualifies as a company at which there's lots of skin in the game:

  • Eric Yuan founded the company in 2011 and still serves as CEO.
  • Insiders, combined, control approximately 35% of voting power, with Yuan holding roughly 20% of both Class A and Class B shares.
  • Employees give Zoom 4.8 stars (out of 5.0) on Glassdoor.com, with Yuan earning a 97% approval rating.

In short, when the people making things happen at Zoom "win," then shareholders -- via stock-price appreciation -- will win, too.

Barbell technique

Finally, we have the barbell technique. This is an idea first introduced to me by the works of Nassim Taleb. The idea is simple: A company should devote about 85% of its time and resources to reliable revenue streams protected by a wide moat. With the other 15%, it should pursue high-risk, high-reward opportunities.

This way, the damage from those opportunities not panning out is minimal -- while the benefits of success are outsized. In effect, this is what the aforementioned "optionality" means: multiple ways to grow the business in fulfilling the company's ultimate mission.

There's no better way to measure the success of Zoom's barbell technique than its net dollar expansion rate (NDER). This tallies all the customers that paid subscription revenue in Year One and compares it to how much the same cohort paid in Year Two. By filtering out the role of new customers, we can see:

  • If customers stay with Zoom over time -- which is likely thanks to high switching costs. When this is true, NDER should be near 100%.
  • If there's optionality, with customers paying more year after year. If this is the case, NDER should be well above 100%.

Zoom only started reporting NDER three quarters ago, but it has clocked in at more than 138% every quarter, representing a very well-functioning barbell technique.

Insane valuation: An exception to my rule

So, given that I'm willing to invest in just about anything growing this fast, what's my problem?

It turns out there is a line past which something is simply too expensive to buy. While the stock has gone down a bit since its all-time highs, let's examine the case just a few days back, on April 23's close:

  • Zoom's price-to-free-cash-flow (P/FCF) stood at 782.
  • Zoom's price-to-earnings (based on net income of $7.6 million last year) stood at 2,368.

But, it could reasonably be argued, those two numbers are misleadingly high, as the company has only just started to become profitable/free-cash-flow positive. Even small improvements in either metric would quickly change these ratios.

That's a fair point. So let's look at Zoom versus some of the other "high-priced" SaaS stocks that I own. These five -- obviously not including Zoom -- make up one-quarter of my real-life portfolio.

Company Price-to-Sales Ratio
Zoom Video 69
MongoDB 27
Veeva Systems 24
Shopify 22
Paycom 20
Zendesk 15

Data source: YCharts. All data accurate as of market close April 23, 2019.

To put this in plain English: Many investors already consider these high-flying SaaS stocks to be expensive. Zoom is between two and a half and three times more expensive than they are!

This makes me think investors getting in now might find themselves in a position similar to those who bought Microsoft back in 2000.

  • Between January 2000 and January 2015, Microsoft the company did well. Sales quadrupled while earnings per share jumped 240%.
  • Over the same time frame, Microsoft the stock did not do well -- returning a grand total of just 11% for investors. And that's including dividends!

Why is there such a divide? Because Microsoft was selling for almost 32 times sales back then. Today, it sits at around 8.5 times sales. You can do the math.

And so I think investors who like Zoom would be better off waiting for better value points. At the very least, if you feel you must own some, I suggest buying a small starter position and adding to it as time goes on. And, as I'm predicting, the stock should give you better and better entry points.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Zoom Video Communications Stock Quote
Zoom Video Communications
ZM
$94.34 (5.61%) $5.01
Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$259.62 (-0.40%) $-1.03
Veeva Systems Inc. Stock Quote
Veeva Systems Inc.
VEEV
$157.99 (-3.09%) $-5.03
Zendesk, Inc. Stock Quote
Zendesk, Inc.
ZEN
$88.18 (-9.21%) $-8.95
Paycom Software, Inc. Stock Quote
Paycom Software, Inc.
PAYC
$266.69 (-2.80%) $-7.69
Shopify Inc. Stock Quote
Shopify Inc.
SHOP
$324.84 (-11.85%) $-43.65
MongoDB Stock Quote
MongoDB
MDB
$223.61 (-8.38%) $-20.44

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
334%
 
S&P 500 Returns
117%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/24/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.