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Is Zoom Video Communications Stock a Buy?

By Herve Blandin – Jun 4, 2020 at 11:01AM

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The video communications specialist posted exceptional first-quarter results, but the competition is intensifying.

Zoom Video Communications (ZM -1.87%) delivered exceptional performance during its fiscal first quarter. In addition, management raised its full-year guidance substantially despite claiming a conservative approach. As the stock price reached its all-time high following these outstanding results, should investors buy Zoom stock?

Outstanding performance

Given that Zoom's stock price had more than tripled since the beginning of the year, there's no doubt the market was expecting the video specialist to show strong first-quarter results. Also, the company communicated in April that its number of daily meeting participants exceeded 300 million, up from 10 million in December, as many people have been using video communications while staying home to try to limit the spread of COVID-19.

But the magnitude of the first-quarter overperformance remains stunning. Revenue grew 169% year over year, and all metrics far exceeded management's guidance communicated at the beginning of March.

Metric Guidance Fiscal Q1 Results
Revenue $199 million to $201 million $328 million
Non-GAAP operating income $25 million to $27 million $55 million
Non-GAAP EPS $0.10 $0.20

Data source: Zoom video communications. GAAP = generally accepted accounting principles. EPS = earnings per share.

The net dollar expansion exceeded 130% for the eighth consecutive quarter, which means existing customers kept on spending at least 30% more than the prior-year quarter to use Zoom's software. And the company also attracted many new customers: The number of customers with more than 10 employees increased to 265,000, up 354% year over year.

That boost is not sustainable given the exceptional coronavirus-induced stay-at-home policies enforced in many countries. Logically, CFO Kelly Steckelberg indicated during the earnings call that the company excepted a higher churn rate during the rest of the year as many small enterprises opted for monthly -- instead of annual -- plans in the face of the coronavirus crisis, and that demand is likely to diminish when the situation settles.

Still, the company is poised to keep on growing over the long term. Most likely, the coronavirus situation accelerated the adoption of video communications. And with its expanding customer base, Zoom can upsell the phone solution it launched last year.

As a result, management upgraded its full-year guidance in a meaningful way to reflect this new reality.

Metric Previous Guidance Updated Guidance
Revenue $905 million to $915 million $1.775 to $1.8 billion
Non-GAAP operating income  $110 million to $120 million $355 million to $389 million
Non-GAAP EPS  $0.42 to $0.45 $1.21 to $1.29

Data source: Zoom video communications. GAAP = generally accepted accounting principles. EPS = earnings per share.

Woman wearing headphones and participating in a video conference call on a laptop in a cafe

Image source: Getty Images.

Intensifying competition

Zoom's huge success brought extra scrutiny to its security and privacy issues, though. CEO Eric Yuan expressed his intention of bringing the company's security to the highest standards, which is a necessary step to protect users and the reputation of the business. However, extra security could reduce the ease of use of its software -- an important competitive advantage for Zoom.

In addition, competition in the video communications market for consumers and enterprises is intensifying.

Deep-pocketed competitors don't hesitate to sacrifice short-term revenue to try to gain consumers' attention. Over the last few months, Facebook announced that its new tool Facebook Room would allow free group video communications. Microsoft's communication software, Skype, doesn't even require the user to download software or create a user account anymore. And Alphabet's Google recently made its video conferencing software Meet free.

In addition, besides the usual competition from giant techs such as Microsoft and Cisco Systems, with their respective communication solutions Teams and Webex, the enterprise market is becoming crowded, too. For instance, in April, giant telecommunications provider Verizon Communications acquired video conferencing platform BlueJeans, and cloud communications specialist RingCentral enhanced its offering with video capabilities.

Besides, Zoom will keep on focusing on video instead of developing a unified communications platform. For instance, it relies on partners such as Box for file sharing and Slack Technologies for chat functionalities. In contrast, these third parties could develop video communication capabilities, as RingCentral did, to integrate collaboration tools under one unique software, which could diminish the attractiveness of Zoom's products.

Is Zoom stock a buy, then?

Zoom remains a spectacular growth stock, though. Yet that doesn't mean it's an attractive investment. So, how does the market value the company?

Based on the midpoint of management's forecasted full-year revenue guidance range, the market values Zoom at an enterprise value-to-sales ratio of 34.2. And the midpoint of the forecasted full-year non-GAAP (adjusted) EPS corresponds to a price-to-earnings (P/E) ratio of 166. 

Given its spectacular results, Zoom deserves to be valued at a premium. But these lofty valuation ratios seem to already price in exceptional performance over the long term, without considering the intensifying competition, which doesn't offer much margin of safety for prudent investors. Thus, at a share price above $200, prudent investors should avoid Zoom stock.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. 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. Herve Blandin owns shares of Cisco Systems. The Motley Fool owns shares of and recommends Alphabet (A and C shares), Box, Facebook, Microsoft, Slack Technologies, and Zoom Video Communications. The Motley Fool recommends Verizon Communications and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, and short August 2020 $130 calls on Zoom Video Communications. The Motley Fool has a disclosure policy.

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