Zoom Video Communications (ZM 1.57%) is one of Cathie Wood's favorite stocks. It is the ARK Innovation ETF's top holding right now, at around 9.5%.
Zoom skyrocketed in popularity during the early stages of the pandemic as more people worked remotely from home. And while businesses had videoconferencing capabilities before 2020, Zoom definitely made doing virtual meetings easier.
Now that people are returning to work in the office, the company's growth has been slowing down. And investors even saw Zoom's profits get cut in half in its most recent quarterly results. Is the business in trouble, or is this still a good growth stock to hang on to?
Image source: Getty Images.
What went wrong for Zoom in Q1?
In the company's first-quarter results for fiscal 2023, Zoom's net income of $113.7 million was just half of the $227.5 million it reported in the prior-year period. Here's a visual breakdown of how the company's profits fell by so much.
Data source: Company filings. Chart by author.
What's positive is that the company's sales grew by more than 12% to $1.07 billion for the period ended April 30. In addition, the company's cost of revenue was actually lower than it was a year ago. That means margins are improving, which can be critical in helping to strengthen the bottom line.
The most notable increase from a year ago were sales and marketing costs, rising by more than $117 million to $362.8 million in Q1. That's likely due to a more aggressive sales approach by the company in order to keep its top line strong at a time when demand may be easing off. General and administrative costs, by comparison, actually fell on a year-over-year basis by 24%. Investment losses and a larger tax bill also contributed to a lower bottom line for Zoom in the quarter.
Zoom's fundamentals are strong despite the decline
Another way to look at the numbers is by reviewing them as a percentage of revenue. Although profits declined in Q1, it may not necessarily be a cause for alarm. That's because Zoom still generated a healthy bottom line that was more than 10% of revenue. Now that things are normalizing for the business after a period of hyper-growth, this may be a truer picture of what investors can expect from the company.
Data source: Company filings. Chart by author.
Zoom's modest cost of revenue results in a solid gross profit margin of more than 75%. That puts it in an excellent position to handle rising costs and still produce a profit. And an item like investment losses may not persist over the long term and could potentially prop up profits in later quarters.
Is Zoom a good investment?
Overall, Zoom's business is strong, and its fundamentals are sound. The company may have simply done so well a year ago that it was hard to replicate those types of numbers, but the company's Q1 results are no reason for investors to worry about the business.
At a price-to-earnings ratio of 27, the stock is a more tenable investment now. A year ago, it was trading at more than 100 times its earnings and was still a bit unproven in its ability to turn a consistently strong profit. Those days are gone, and today the company is a safer buy, meaning its stock could make for a solid long-term investment.
