What do the world's most successful investors do when their favorite stocks get beaten down? If your name's Cathie Wood and Zoom Video Communications (ZM 3.63%) is the stock getting hammered, you buy a lot more.
On Tuesday, Aug. 23, while Zoom's stock price was tanking, ARK Invest added a combined 839,000 shares to the ARK Innovation ETF and ARK Next Generation Internet ETF. Now Zoom is ARK Invest's third-largest holding.
Just looking at the headline numbers, it's easy to see why the stock slid more than 16% in a day. Below the surface, though, there were some signs of success that encouraged Wood to buy heaps more shares to hold for the long run.
Why Zoom Video Communications stock fell
When Zoom reported fiscal first-quarter earnings in May, management told investors to expect between $1.115 billion and $1.120 billion in revenue for the fiscal second quarter ended July 31, 2022. The stock cratered because top-line revenue missed the low end of the company's own expectations at just $1.0995 billion.
Wall Street analysts were also disappointed with a revenue outlook for the full year that the company lowered from $4.54 billion at the midpoint of the guided range provided in May to $4.39 billion. Net income during the fiscal second quarter fell by 50% year over year but remained positive at around $114 million.
Why Wood expects a strong comeback
During the heat of the pandemic, Zoom reinvested plenty of its enormous cash flows into research and development. Cathie Wood and ARK Invest haven't lost faith in Zoom's ability to maintain its leading position in the communications-as-a-service industry because those investments are working.
Zoom Phone is a unified app for phone, video, meetings, and chat. Employers adopting hybrid work arrangements can't seem to get enough of it. The company added over 1 million new Zoom Phone seats in the fiscal second quarter, which pushed the total past 4 million.
Clearly, Zoom's not having trouble gaining clients that already have access to competing communication tools such as Microsoft Teams. The number of customers with 10,000 or more paid seats jumped 112% year over year.
Wood's more than likely encouraged by Zoom's ability to grow its client roster without relying heavily on discounts that could eat into the bottom line. The company reported an adjusted operating margin of 36% in the fiscal second quarter and expects a 33% adjusted operating margin in the quarters ahead.
Time to buy?
At its recently reduced price, shares of Zoom trade for just 22.1 times the company's adjusted earnings estimate for the fiscal year that ends in January 2023. The average stock in the Nasdaq 100 index currently trades at 24.4 times forward-looking earnings estimates. In other words, the market is behaving as if Zoom is going to grow at a rate that's less than average for the 100 largest companies on the Nasdaq exchange.
If Zoom didn't have incredibly popular new communications services for enterprise clients, I'd be worried about the company's ability to grow over the long run, too. With clear success for Zoom Phone and younger initiatives such as Zoom Contact Center picking up steam, this company clearly knows how to stay several steps ahead of the competition.
I'm not sure I'd make Zoom one of the largest positions in my portfolio as Wood has done with ARK Invest ETFs. Strong profitability now, the means to keep ahead of competitors, and a sensible valuation, though, would make it a great addition to any well-diversified portfolio.