Zoom Video Communications (ZM 1.46%) has a case for winning the award of poster child stock during the pandemic. Society leaned heavily on its video-conferencing software when lockdowns prevented face-to-face interactions. But after a fun ride, the stock has bucked the rails in 2022 and is now down 87% from its high.
Investors are left grappling with whether Zoom's long-term potential looks more like the stock did during the pandemic or during 2022. So to help make that decision, here are two reasons to buy shares today and one reason to sell.
Reason to buy: Easy path to earnings growth
Zoom is a communications software platform. Most know it as a video call tool, but its capabilities stretch beyond that to event management, collaboration tools, call center software, and more. Today, Zoom has more than 213,000 enterprise customers and generated nearly $4.4 billion in total revenue in its 2023 fiscal year, ended Jan. 31. The business is profitable at that size -- Zoom turned $0.27 of every revenue dollar into free cash flow in the fiscal year 2023 and earned $4.37 per share.
While you buy many stocks hoping the company turns a profit someday, Zoom is already delivering tons of cash and bottom-line earnings. Management is growing its enterprise business, which increased 24% in the fiscal year 2023 from 2022. Total revenue growth was just 7% because of a decline in online revenue (coming down from pandemic tailwinds). But over time, the enterprise business, which currently represents 54% of total sales, ideally will steer the ship.
Analysts expect a short-term retraction in earnings per share (EPS), calling for $4.09 versus the fiscal 2023's $4.37. However, the long-term outlook remains bright. Analysts expect EPS growth to average 25% annually over the next three to five years.
Reason to buy: A bargain-basement valuation
When you combine strong earnings growth with a cheap valuation, the result can be magical for your portfolio. The market's cold shoulder toward Zoom has depressed the stock's valuation to very attractive levels. Consider that the S&P 500, which historically grows at about 10% annually, trades at a price-to-earnings (P/E) ratio of nearly 18.
That makes Zoom stock look like a bargain at a P/E of 16, given the expected EPS growth over the coming years. Of course, there's a chance that Zoom's growth doesn't come through as expected, but the company does have a significant lever to pull if needed. There is currently just over $5 billion in cash against zero debt. Given Zoom's current $20 billion market capitalization, that's a whopping 25% of the company's market value sitting in cash. Management could easily repurchase a substantial amount of shares to help drive EPS growth higher.
ZM PE Ratio (Forward) data by YCharts
Solid EPS growth may boost investment returns via a higher valuation on shares. But disregard that, and Zoom can still be a good investment if it grows EPS by double-digits because the current valuation is so low.
Reason to sell: Revenue growth struggles
The low valuation and potential EPS growth are great reasons to like the stock, but all companies need revenue growth, and this is where Zoom is struggling right now. You can see below that Zoom has continually spent more on sales and marketing, but it still hasn't prevented revenue growth from collapsing over the past year.
ZM Sales and Marketing Expense (Quarterly) data by YCharts
A long-term investor looks at the business and sees long-term questions that aren't yet answered. What would growth look like if Zoom pulled back on marketing spending? How much longer must Zoom spend this aggressively to drive growth?
The good news is that revenue hasn't contracted, and that shouldn't happen in fiscal 2024 either. Management is forecasting revenue of $4.43 billion to $4.45 billion, roughly flat year over year. These troubling questions help explain why the stock has been devalued so much, even with its strong cash position and profitability.
What to look for moving forward
The stock seemingly has more near-term upside than downside risk. The valuation is very attractive, and that cash could go a long way in helping EPS growth. The picture isn't as clear the further you look ahead. Investors should monitor Zoom's enterprise business for continued growth that hopefully more than offsets declining online revenue.
Zoom's investment returns will largely hinge on management's execution, but it's hard not to like the margin of safety you can get at today's prices.
