Zoom Video Communications (ZM 1.13%) was a big winner during the pandemic when COVID-19 lockdowns had the world communicating through video. These days, Zoom is no longer beloved; investors have fled the stock, which has fallen more than 85% from its high.
Here is why Zoom can still be a lucrative addition to a long-term investor's portfolio, even if it never again sees the kind of growth it saw during the pandemic.
Acknowledging the passing of the golden times
There's a misconception that the pandemic was the only reason for Zoom's growth. You can see below that although there was an apparent surge in growth during the lockdowns, Zoom was growing revenue nearly 100% year over year before that.
ZM revenue (quarterly YoY growth). Data by YCharts. YoY = year over year. TTM = trailing 12 months.
Zoom's year-over-year revenue growth approached 400% at its peak, a figure that will probably never happen again, especially now that the company is growing from a multibillion-dollar revenue base. Growth is often harder to increase as the numbers involved get larger.
Many investors are likely souring on the stock because the company's growth has plunged to the single digits. But remember that Zoom is just coming out of its pandemic growth spurt; that means that the low growth is being compared to an abnormally substantial increase the previous year, and the pandemic likely pulled forward some demand for Zoom's services. Companies might have begun using Zoom sooner than anticipated because lockdowns forced their hand.
Zoom is a very profitable business
It would be a serious red flag if Zoom's growth slowed while the company continued losing money, but that's not the case here. It is very profitable, converting 35% of its revenue into free cash flow and posting a healthy net income of $990 million over the past year. The company is also sitting on $5.5 billion in cash against zero debt.
ZM free cash flow. Data by YCharts.
Zoom's strong financials give the company many options; it could look for a strategic acquisition to reignite growth or strengthen its business model. It could even repurchase shares to help grow earnings per share (EPS); it has enough cash to retire a whopping 23% of its outstanding shares.
Investors will need to see what Zoom does; the company tried but failed to acquire Five9 for $14.7 billion last year, so it has shown a willingness to shoot for a big deal when the opportunity arises.
An attractive valuation that offsets slowing growth
Despite its rapid growth, Zoom's stock appreciated too fast during the pandemic. The company's valuation soared to nosebleed heights, regardless of whether you valued Zoom by its revenue via price to sales (P/S) or by its profits via price to earnings (P/E). Valuations like a P/S over 100 or a P/E over 1,000 rarely make sense, and sure enough, the stock's valuations came crashing back to earth.
ZM PS ratio. Data by YCharts.
The good news is that investors can now buy shares at a valuation that makes sense, even in the face of slower revenue growth. The company's P/E of 25 is rational for a company poised to grow EPS at an average of 14% annually over the next three to five years, which analysts' estimates call for.
Keep tempering expectations. The stock probably won't approach its former highs soon -- the valuation was far too rich. But investors can reasonably expect returns on par with the company's growth, which could still be suitable for most investors if Zoom can hit and maintain the double-digit gains analysts expect.
