4 Reason to Buy Zoom Video Communications, 1 Reason to Sell

Zoom Video Communications (ZM 1.46%) posted its first-quarter earnings report on May 23. The online video conferencing company's revenue rose 12% year-over-year to $1.07 billion, which matched analysts' expectations. Its adjusted net income declined 21% to $316 million, or $1.03 per share, which still beat analysts' expectations by $0.16.

Zoom's headline numbers were mixed, but its growth seems to be stabilizing in a post-lockdown world. Let's review four reasons to buy Zoom -- as well as one reason to sell it -- to see if it can bounce back.

Image source: Zoom.

1. Its growth rates are stabilizing

Zoom experienced explosive growth during the pandemic as more people shifted to remote work and online classes. But as the lockdown measures were relaxed, Zoom's growth decelerated:

Data source: Zoom. YOY = Year-over-year.

At the end of fiscal 2022, which ended this January, it seemed like Zoom's sequential growth would also flatline. However, it now expects to generate up to $1.12 billion in revenue in the second quarter of fiscal 2023, which would represent 5% sequential growth and 10% year-over-year growth. 

For the full year, it expects its revenue to rise between 10% and 11%. Next year, analysts expect its revenue to rise about 13% as the year-over-year comparisons gradually normalize.

Zoom says the Russo-Ukrainian war "broadly" impacted its European business, but it expects its growth across the Americas and Asia-Pacific regions to largely offset that slowdown.

2. It's still gaining higher-value customers

Zoom's top-line growth is cooling off, but it continues to lock in large customers. Its total number of higher-value customers that contributed over $100,000 in trailing 12-month (TTM) revenue rose 46% year-over-year (and 7% sequentially) to 2,916 during the first quarter.

Data source: Zoom. *Generated over $100,000 in TTM revenues.

That stable growth suggests Zoom isn't ceding the video conferencing market to aggressive challengers like Microsoft (MSFT -1.84%) Teams, Cisco's (CSCO 0.67%) Webex, and Alphabet's (GOOG 0.37%) (GOOGL 0.35%) Google Meet.

Zoom's total number of enterprise customers rose 24% year-over-year to 198,900 during the first quarter. It also maintained a TTM net dollar expansion rate of 123% among those enterprise customers.

3. Its gross margins are expanding

The bears will claim that Zoom will lose its pricing power as Microsoft, Cisco, Google, and others offer more free services and competitive bundles. However, Zoom's gross margins have continued to expand over the past year on a non-generally accepted accounting principles (non-GAAP) basis.

Data source: Zoom. Non-GAAP.

Furthermore, Zoom expects to maintain gross margins between 76% and 78% for the rest of the year, compared to its prior guidance in the mid-70s. During the conference call, CFO Kelly Steckelberg attributed that ongoing expansion to the optimization of its "usage across the public cloud" as well as an "increasing number of co-located data centers."

4. Its valuations look fairly reasonable

Zoom's stock got incredibly overheated when it hit an all-time high of $568.34 back in October 2020. But at $110 per share, Zoom now trades at 24 times forward earnings and seven times this year's sales.

It's not a screaming bargain yet, but its downside potential could be limited at these levels as investors reset the expectations for Zoom and focus on the potential expansion of its ecosystem with newer products and features like Zoom Phones, Zoom Events, and the Zoom Contact Center.

The one reason to sell Zoom: Its operating margins

Zoom's gross margins are healthy, but its operating margins have gradually declined over the past year:

Data source: Zoom. Non-GAAP.

That contraction was mainly driven by a spike in its R&D expenses, which more than doubled year-over-year in the first quarter of 2023 as it ramped up its spending on new products and services. Its sales and marketing expenses also jumped 40% as it aggressively promoted its platform.

Zoom expects that elevated spending to continue throughout the rest of the year. It's bracing for a 32% to 34% year-over-year drop in its non-GAAP EPS in the second quarter of 2023, and a 26% to 27% decline for the full year. Analysts expect just 9% earnings growth in fiscal 2024.

Zoom is still an unappealing investment

Zoom won't fade away anytime soon, but it's ramping up its spending as its growth decelerates. That toxic combination makes it an unappealing investment in this challenging market, and it could remain in the penalty box until its revenue growth stabilizes and its operating margins expand again.