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Zoom Stock Should Worry Investors, But Not Because of Security Concerns

By Will Healy – Apr 12, 2020 at 10:00AM

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Investors in this video conferencing specialist have to worry about security of a different kind.

The coronavirus-related lockdowns have become a surprise boon to Zoom Video Communications (ZM -1.18%), as users who had never used online meeting platforms before have turned to its product. While most stocks have fallen in value this year, Zoom stock has risen by about 75% year-to-date.

However, security-related fears have led investors to sell off the stock in recent days. Although security remains a concern for Zoom, the safety of Zoom stock at its current price should become a more critical concern to investors.

Zoom prospers amid security concerns

As efforts to halt the spread of COVID-19 have forced millions to shelter at home, many turned to Zoom to set up meetings without having to create an account. Popularity grew further as the company allowed users to set up a meeting with up to 100 people for free. It also offered its premium features to educators for free during the COVID-19 lockdown crisis.

This sudden surge in usage changed the outlook for Zoom. According to CEO Eric Yuan, Zoom usage rose from 10 million daily meeting participants one year ago to over 200 million today.

Man with a beard and glasses waves to his laptop as he participates in a video conference.

Image source: Getty Images

However, the lack of need for an account also made it easier for hackers to intrude on meetings. As a result, security breaches led several school districts to abandon the platform. Zoom responded by updating some security measures and promising to add additional security features in short order.

Since making this move, Zoom has seen the sell-off of its stock slow considerably. However, this renewed support for the company does not seem to factor in the real risks of an investment in Zoom at its current inflated stock price. Investors will need much more than a security update from the company to address this issue.

Just to be clear, this is not an issue of the company's stability. It turned profitable in 2019. Moreover, analysts forecast revenue growth of 49.3% this year for the San Jose, California-based video communications company.

Zoom has nowhere to go but down

Zoom launched its IPO about a year ago, opening at $65 per share. At today's much higher price, the popularity of the product has taken the company's forward P/E ratio to just above 263!

ZM Chart

ZM data by YCharts

In a sense, its price surge is not surprising as hot tech stocks often see premium valuations. Nonetheless, it has become apparent that Zoom has moved ahead of itself. Furthermore, the lockdown that made Zoom more popular cannot last. 

In time, the pandemic will run its course, or scientists will find an effective treatment. Getting the virus under control will allow society to reopen, and many who are currently in its expanded user set will inevitably abandon Zoom to again meet in person. I do not expect Zoom's daily participation rate to fall back to 10 million. However, investors should expect post-coronavirus daily usage to come in closer to 10 million than 200 million.

As interest wanes, so too will Zoom stock in all likelihood. Even with profit growth expected to average 32.5% per year over the next five years, such growth will probably not sustain a P/E ratio at current levels.

Zoom and its competition

Investors should also remember that users have numerous video conference options available to them. Microsoft's Skype and Teams apps, Cisco's Webex, Adobe Connect, LogMeIn's GoTo Meeting, and numerous other platforms offer similar features. More recently, this list also includes Facebook, which recently introduced an additional video conferencing app to the marketplace.

Moreover, unlike Zoom, online meetings are one of many software offerings for these other tech giants. This leaves Zoom stock vulnerable if one of these peers finds a competitive advantage. At a market cap of about $34 billion, Zoom is also a considerably smaller company than its mega-cap competitors. The fact that it can grow its user base and earn profits in such an environment speaks well of the company. However, investors need to remain mindful of its competitive position compared to such tech heavyweights.

Investors should brace for the inevitable drop in usage once the COVID-19 pandemic runs its course. Nonetheless, they should also keep this tech stock on their watch lists. The company found a way to build a user base and turn profitable in the face of intense competition.

Still, its elevated P/E ratio and a likely drop in usage bode poorly for the stock's near-term future. Unless the stock price falls to a valuation more in line with the company's long-term growth rate, investors should stay on the sidelines.

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Will Healy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook, Microsoft, and Zoom Video Communications. The Motley Fool recommends Adobe Systems and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, and short May 2020 $120 calls on Zoom Video Communications. The Motley Fool has a disclosure policy.

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