Zoom Communications (ZM -0.51%) seemed to sprint on the scene amid COVID-19, when millions of new users suddenly became drawn to the platform. Now, even with the stock close to record levels, demand for online meetings could fall as the contagion recedes. However, the pandemic's end could also bring a potentially larger threat to the forefront that could undermine the value proposition of this tech stock.
COVID-19 and changes to the workplace
COVID-19 made Zoom one of the more notable success stories of the pandemic. People and businesses turned to the site as the pandemic's infection risks made in-person meetings increasingly unsafe.
Now, pandemic conditions appear poised to recede. The healthcare industry has already administered 46 million COVID-19 vaccines. Moreover, the number of new COVID-19 cases has fallen in recent days.
While one might view this as a negative for Zoom, reopening offices may not necessarily spell doom for the platform. Since online meetings worked for many purposes and reduced the need for travel, investors should expect these platforms will remain an essential tool.
Also, Zoom stands out for more than what it offers at no cost. For one, only one user needs to download Zoom, which is not the case with Cisco's Webex or Microsoft's Skype. Everyone else may access from a laptop or mobile device without adding the company's app. Furthermore, Zoom also can house multiple rooms on a single call. Free Zoom calls can also accommodate up to 100 people, more than Skype's limit of 50.
The state of Zoom
Unfortunately, these features do little to widen Zoom's competitive moat. Nothing can stop its peers from copying or surpassing those aforementioned features if they chose to do so. Also, new entrants remain a potential issue, as Zoom competitor ON24 launches its IPO.
Additionally, while Zoom has grown to a market cap of more than $125 billion, it remains much smaller than peers such as Microsoft and Alphabet's Google. Both of these companies maintain market caps of over $1 trillion and hold cash hoards exceeding Zoom's market cap.
Thanks to their liquidity and more diverse sources of revenue, these companies could either invest in improving their platforms or offer more advanced features at a lower cost. Such moves could induce more customers to drop Zoom.
Admittedly, this potential competition has not stopped Zoom so far. Revenue for the first nine months of 2020 more than quadrupled from the same period in 2019 to just under $1.8 billion. Over that period, Zoom earned over $411 million, or $1.38 per diluted share. The company reported a profit of just under $7.5 million in the first nine months of 2019.
Given that growth and its rising popularity during the pandemic, one can understand why the stock rose by more than 380% in the last 12 months.
However, Zoom now supports a 300 P/E ratio and a price-to-sales (P/S) ratio of about 65. These multiples have fallen significantly since last year, when the P/E reached 2,000 and the P/S ratio peaked at around 120. Still, Zoom is hardly the only tech stock with comparable valuations, and the current earnings and sales multiples magnify the company's vulnerabilities. Should competition lead users away from the platform, the high valuation could make Zoom's decline all the more dramatic.
Can investors continue to capitalize?
Free usage options and improved functionality have made Zoom's online meetings platform popular. However, the threat of competition looms large over Zoom, even as the stock itself has zoomed to elevated levels. This could cause concern for investors as the company has no obvious response if larger competitors offer better service and more functionality at a lower cost. Such potential alone might make Zoom stock not worth the risk.
This article represents the opinion of the writer(s), who may disagree with the "official" recommendation position of a Motley Fool premium advisory service. We're motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.