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Is Zoom Stock Overvalued?

By Trevor Jennewine - Mar 16, 2021 at 7:30AM

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This tech company trades at a pricey valuation, but there's more to the story.

Zoom Video Communications (ZM 2.78%) has been one of the biggest winners of pandemic-driven social distancing. Over the last 12 months, the share price has surged 220%, and the stock currently trades at 39 times sales and 154 times earnings. This may have some investors asking themselves: is Zoom overvalued?

The answer to that is no. Here's why.

Zoom Video has a big market opportunity

Zoom's platform provides unified communications as a service (UCaaS). In other words, it connects people, allowing them to share content and communicate through channels like video, voice, and text.

Woman using Zoom Meetings to talk with nine other people.

Image source: Zoom

The company's core product, Zoom Meetings, skyrocketed in popularity last year as friends, families, students, and employees needed safe, socially distanced ways to interact. Of course, the pandemic also boosted competing solutions like Microsoft Teams and Cisco Webex. But Zoom's astonishing growth has helped it achieve a greater market presence than any of its rivals.

Moreover, other Zoom products are also gaining traction with customers. For instance, Zoom Phone is a cloud-based system for enterprises. It allows employees to make calls directly from the Zoom platform using their desk phone, mobile phone, or computer. Compared to on-premise systems, cloud-based phones are cheaper and require less time to implement. Zoom Phone also offers advanced features like call recording and voice mail transcription to improve employee productivity.

Despite launching just two years ago, the company has already sold over 1 million Zoom Phone seats. And in fiscal 2021 (ended Jan. 31, 2021), the number of Zoom Phone customers with more than 10 employees jumped 269%. That's encouraging, especially since management sees this as a $23 billion opportunity by 2024.

And that's just a portion of the company's total addressable market. According to Nextiva, the global UCaaS market is expected to reach $140 billion by 2025 -- more than 50 times Zoom's trailing 12-month revenue. That gives the company a long runway for growth.

Strong financial performance

Not surprisingly, as businesses and schools closed in response to the coronavirus pandemic, Zoom's customer growth accelerated sharply. The company ended the year at roughly 467,100 customers (with over 10 employees), up 470% from the previous year. Moreover, the number of customers paying more than $100,000 per year jumped 156% to 1,644.

This strong adoption rate translated into incredible growth in revenue and free cash flow.

Metric

2020

2021

Change

Revenue

$622.7 million

$2.7 billion

326%

Free Cash Flow

$113.7 million

$1.4 billion

1,118%

Source: Zoom SEC filings.

Finally, investors should note that Zoom's dollar-based net expansion rate has now exceeded 130% for each of the past 11 quarters. In other words, Zoom's customers are consistently spending more each year. Apart from boosting its top and bottom lines, this also strengthens Zoom's competitive advantage: As customers spend more, they become more dependent on Zoom's platform, which translates into higher switching costs.

Zoom's valuation

Zoom's current valuation certainly isn't cheap, but it is cheaper than it was one year ago. In fact, over the last 12 months, the company's price-to-sales ratio has dropped 11% and its price-to-earnings ratio is down 88%.

Regardless, I believe Zoom's incredible growth and massive market opportunity justify its current valuation. The pandemic emphasized the importance of use cases like remote work, remote learning, and telemedicine. Even when social distancing measures are relaxed and life returns to "normal," those changes won't simply vanish.

For example, it's much cheaper and more convenient for a business to meet with clients virtually (through Zoom's platform) than it is to make the trip in person. The same argument applies to students, patients, friends, and family. That's not to say that in-person meetings will no longer be important -- of course they will. But as the pandemic fades, Zoom will play an important role in establishing the "new normal." That's why the stock looks like a buy even at today's valuation.

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Stocks Mentioned

Zoom Video Communications Stock Quote
Zoom Video Communications
ZM
$110.97 (2.78%) $3.00
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$259.58 (1.07%) $2.75
Cisco Systems, Inc. Stock Quote
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$42.60 (-0.09%) $0.04

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