If you bought shares of Zoom Video Communications (ZM -0.82%) at the start of 2020 and held on until now, your total gain would be just 5%. You would have seen the tech stock's boom and bust all within a period of less than three years. Zoom's videoconferencing app was synonymous with remote work, and now its stock is symbolic of how quickly excitement can turn into despair.
Zoom is not going out of business, but its sales have stalled, its expenses are rising, and the growth it will achieve from here on out is questionable at best. Down 62% this year and trading at a more modest 31 times earnings (versus the near 50 times profits it was at to start 2022), it may seem like a tempting buy on the dip. But there is one number you should take a careful look at before you decide to buy shares of Zoom.
A closer look at Zoom's operating income
The number I'm talking about is Zoom's operating income -- $66.5 million -- which it reported in its most recent quarter (ended Oct. 31). That is down a whopping 77% from the same period last year. And unlike net income where investment gains and losses have often distorted Zoom's bottom line, operating profits can give investors a better indication of how the business is performing.
The reason operating profits have taken such a beating isn't falling sales; Zoom's top line was up a modest 5% last quarter, climbing to just above $1.1 billion. Even cost of revenue at $270.7 million is nearly identical from the prior-year period. The problem is further down the income statement.
Operating expenses have soared 56%
At $764.7 million, operating expenses ate up 92% of the company's gross profit. And that means its operating margin has nearly evaporated. Just like Zoom's stock, things started out well but now are back to around where they were at the start of 2020.
ZM Operating Margin (Quarterly) data by YCharts
There are signs that the company has simply become bloated with expenses during the pandemic. Across the board, the company incurred more expenses for general and administrative expenses, sales and marketing, and research and development. Of these, research and development expenses rose the most, essentially doubling in just a year.
What's even more concerning is that in the company's earnings report, Zoom didn't outline any attempt to curb these costs. Instead, it cautioned that for each of these items, it expects its expenses to increase "both in absolute dollars and as a percentage of revenue for the rest of the current fiscal year."
While other tech companies have been slashing costs in an effort to make up for softer demand, Zoom doesn't appear to be going in that direction at all. And that should be a big red flag to investors, as the company's operating income may continue to plummet even further.
Why I'd avoid Zoom's stock
Zoom's growth is questionable at this stage as the company is clearly having difficulty expanding its top line. It's especially concerning when sales and marketing efforts are up but there's no translation into a stronger top line.
At a time when companies are taking a close look at their budgets and preparing for a possible recession next year, I don't like the odds of much growth for Zoom's business in 2023. Not when it can potentially cost a business hundreds of dollars per user to use Zoom's services and there are so many competing options out there. Microsoft Teams, for instance, is included within a Microsoft 365 subscription.
I'm not optimistic that Zoom can be competitive in a tougher economy next year. The tech stock is not worth paying 30 times earnings for, and that multiple could look even worse if Zoom's bottom line doesn't recover quickly.
