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Should You Buy Zoom Stock Right Now?

By Daniel Sparks – Sep 3, 2020 at 6:23AM

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Shares of the videoconferencing company have skyrocketed 500% this year. Is there more upside ahead?

Zoom Video Communications (ZM -1.18%) has probably caught your attention at least a few times in 2020. The videoconferencing company has become the go-to solution for helping people collaborate face-to-face over the internet. Indeed, there's a good chance you or someone in your family has actually used the product this year. Adoption of the video platform, of course, has been fueled by the coronavirus pandemic, which led to stay-at-home orders and a huge increase around the globe in the number of people working from home.

If you've been living in a cave and you haven't heard of Zoom's videoconferencing product, maybe you've seen headlines about the technology company's soaring stock. Shares of Zoom are up more than 500% this year, with the most recent sharp move higher following quarterly results earlier this week that obliterated expectations.

If you've been sitting on the sidelines watching in awe, perhaps yet another incredible quarterly report has you wondering whether or not you should buy this hot growth stock.

Let's take a closer look at Zoom stock to see if it looks attractive today.

A man using Zoom to videoconference with colleagues on his computer

Image source: Zoom Video Communications.

Monstrous growth

When Zoom reported its fiscal first-quarter results in June, the company beat expectations -- and then some. Zoom's revenue soared 169% year over year to $328.2 million, crushing an average analyst forecast for revenue of $202.7 million. Even more, the company approximately doubled its outlook for full-year revenue. At the time, management said it expected fiscal 2021 revenue to be between $1.775 billion and $1.800 billion -- up from a previous forecast for revenue between $905 million and $915 million.

With such a strong quarter behind it, investors and analysts had high expectations going into Q2 -- but those expectations weren't high enough. Second-quarter revenue soared 355% year over year to $663 million and non-GAAP (adjusted) earnings per share jumped from $0.08 in the year-ago period to $0.92. Analysts, on average, were expecting revenue of $501 million and adjusted earnings per share of $0.45.

Even more, Zoom once again gave its full-year outlook a huge upgrade. Now management is expecting full-year fiscal 2021 revenue to be between $2.37 billion and $2.39 billion (Don't forget, management was initially expecting about $910 million in total revenue during fiscal 2021). The company said it expects fiscal third-quarter revenue to be between $685 million and $690 million -- a notable uptick from Zoom's impressive fiscal second quarter.

A soaring stock price makes sense

Zoom's wild business growth certainly merits a soaring stock price in 2020. No one would have guessed how significantly the company would benefit from people all over the world sheltering at home and organizations embracing more work-from-home solutions. More importantly, Zoom founder and CEO Eric Yuan indicated in the company's fiscal third-quarter earnings call that he believes the spike in adoption in video collaboration technology is here to stay, even as the economy reopens.

"As remote work trends have accelerated during the pandemic," Yuan explained, "organizations have moved beyond addressing immediate business continuity needs to actively redefine and [embrace] new approaches to support a future of working anywhere, learning anywhere, and connecting anywhere."

Should investors buy, sell, or hold Zoom stock today?

But is Zoom really worth its $119 billion market capitalization today?

In just one of many ways to value Zoom stock, investors can assume that the company can sustain its projected fiscal third-quarter revenue ($685 million to $690 million) over the next four quarters. This would result in annual revenue of about $2.75 billion. If the company can continue converting about 56% of its revenue into free cash flow as it did in fiscal Q2, this would translate to $1.54 billion in free cash flow. In other words, Zoom is currently trading at about 77 times a forward estimate of Zoom's annual free cash flow.

A person hitting the buy button on a keyboard

Image source: Getty Images.

Zoom, therefore, certainly commands a pricey valuation. Even more, if Zoom's revenue growth rate falls off a cliff in fiscal 2022 and beyond, and the coronavirus pandemic proves to be a short-lived catalyst for the company, shares could appreciate very little or even decline. However, investors should note that Zoom was already growing its revenue at a rate of 88% year over year for the fiscal year ended Jan. 31, 2019 -- before COVID-19 hit the U.S. So continued strong growth is likely to persist, albeit at a much slower rate than what the company has demonstrated in fiscal 2021.

In short, Zoom stock may still be worth buying today -- as long as the position is kept small and investors plan to hold for five years or more. 

Of course, no stock investment is without risk. Not only should investors plan for a bumpy ride given the stock's high valuation, but investors should note that shares could take a hit if competition begins making inroads on Zoom. If the company's lead in videoconferencing begins to diminish, investors may have to revaluate whether Zoom shares are worth holding onto at this lofty price tag.

Daniel Sparks has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Zoom Video Communications. The Motley Fool has a disclosure policy.

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