Being honest about the future isn't easy when the outlook sours. Zoom Video Communications (ZM 0.05%) found itself in this situation lately, and it didn't work out so well for the stock.
Shares of Zoom quickly fell by 10% the morning after management presented results from its fiscal third quarter that ended on Oct. 31, 2022. Instead of hitting the sell button in a panic, let's look below the surface to see if the factors that made Zoom a smart stock to buy in the first place are still in play.
What happened to Zoom Video Communications stock?
The performance of Zoom's underlying business during its fiscal Q3 wasn't anything to complain about. Total revenue rose 7% year over year if we adjust for the strengthening U.S. dollar.
It was the revisions Zoom made to its revenue outlook that brought the hammer down. Management lowered top-line revenue expectations for fiscal 2023, which ends on Jan. 31, 2023, by $15 million to a range between $4.37 billion and $4.38 billion.
Zoom lowered its revenue outlook in response to unfavorable foreign exchange dynamics, not declining demand. That said, management did say that its sales teams are experiencing heightened deal scrutiny when it comes to signing new enterprise clients.
Why it probably isn't a good time to sell
In 2020, COVID-related lockdowns forced businesses of all sizes to scramble for work-from-home solutions. Now that the dust has settled, heaps of individuals and smaller businesses that no longer need a work-from-home solution are ending their Zoom subscriptions.
Smaller clients leaving their subscriptions isn't good, but it doesn't mean that Zoom is doomed. Large enterprise clients are climbing aboard, and they could more than offset the loss of smaller clients.
New services, like Zoom Contact Center, go way beyond facilitating weekly meetings with employees, and larger clients are noticing. For example, Qualtrics, a company that handles experience management for many of the world's largest businesses, is a Zoom customer that recently upgraded its subscription.
In Q3, Zoom expanded its roster of enterprise clients by 14% year over year to 209,300. There were 3,286 clients contributing over $100,000 in revenue over the trailing-12-month period, which was 31% more than there were a year earlier.
Image source: Getty Images.
What's next?
Holding on to shares of a stock after it's fallen hard can be challenging psychologically, but hanging on to Zoom could pay off well over the long run. Clients that spend more than $100,000 annually will generally find it more difficult to end their subscriptions than smaller clients. These big customers are responsible for 27% of total revenue at the moment.
There could be a lot of turmoil as revenue shifts from smaller clients to those with enterprise-level subscriptions. Over the long run, though, those enterprise clients will probably deliver more reliable cash flows.
Shares of Zoom have collapsed, but the stock is probably near its bottom. The stock is trading at just 21.5 earnings expectations for the year ahead. This is an appropriate valuation for businesses expected to grow their bottom lines at mid-single-digit percentages, but we can expect more from Zoom. Heaps of deep-pocketed enterprise clients climbing aboard could allow the company's bottom line to start soaring again. With this in mind, letting go of Zoom stock at its currently depressed price seems like a bad idea.
