Please ensure Javascript is enabled for purposes of website accessibility

There’s a Big Problem With Zoom Stock

By Timothy Green - Mar 26, 2020 at 7:45AM

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

Panic-buying the red-hot video conferencing stock probably won’t end well.

While the stock market has tumbled over the past month as the novel coronavirus outbreak shifted from something happening in China to a global pandemic, certain stocks have bucked the trend. Zoom Video Communications (ZM 7.38%), a provider of subscription-based video conference software, is one of them. Since the start of 2020, Zoom stock has more than doubled, while the S&P 500 is down nearly 25%.

The story behind Zoom's outperformance makes a lot of sense. As businesses, schools, and other organizations require employees to work remotely amid the pandemic, demand for video-conferencing capabilities is surging. Zoom was already growing quickly before the pandemic, with revenue up 88% in fiscal 2020. That growth rate will now almost certainly accelerate, at least for a while.

Zoom was also profitable on a GAAP basis last year, a rarity among fast-growing software-as-a-service companies. It's hard to claim that Zoom isn't a great company, given its results.

But great companies aren't always great investments. At the wrong price, the best company in the world will provide investors with abysmal returns. Quality matters, but price matters, too.

For Zoom, the price is very wrong.

Zoom software on a laptop.

Image source: Zoom.

Detached from reality

In Zoom's pre-IPO S-1 filing, the company claimed that its total addressable market would reach $43.1 billion by 2022. This number was based on estimates from IDC for various portions of the communication and collaboration market. Zoom claimed that it addressed the hosted/cloud voice and unified communications, collaborative-applications, and IP telephony lines segments.

If there's one thing you can be sure of in an S-1 filing for any hot company, it's that the total addressable market is being inflated as much as possible. The collaborative-applications segment, for example, includes all sorts of stuff that Zoom has no part in, like cloud-based productivity software.

Zoom is not the worst offender by a long shot. Fake-meat company Beyond Meat claimed it addressed the entire $1.4 trillion global meat industry. Foam-mattress provider Casper Sleep pointed to a $432 billion market opportunity that encompassed everything even tangentially related to sleep.

Still, Zoom is probably overestimating the opportunity. The video-conferencing market itself was worth just over $6 billion in 2019, according to Transparency Market Research, and it's expected to grow by just 8.4% annually from 2020 to 2027.

To put these numbers into context, Zoom is currently valued just below $40 billion. In other words, the company's market capitalization is nearly as large as its (likely inflated) total addressable market in 2022, and more than six times as large as the video-conferencing market today.

You could argue that the pandemic will accelerate video conferencing adoption, but the valuation makes no sense relative to the company's market opportunity.

Relative to sales, Zoom stock is also exceptionally expensive. The company generated revenue of $622.7 in fiscal 2020, putting the price-to-sales ratio at nearly 64. That ratio is much lower if you use expected sales for the current year, but it's still in the dozens.

Zoom is one of the few stocks soaring this year. The story behind the company is compelling. The company will probably continue to do well, even after the pandemic ends and it loses some of its new customers. But the stock is a disaster waiting to happen.

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
$90.94 (7.38%) $6.25

*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
327%
 
S&P 500 Returns
116%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/19/2022.

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.