If there's one stock I never fully understood the hype behind, it's Zoom Video Communications (ZM -1.09%). Videoconferencing was not a new phenomenon in 2020 by any means, but at the outbreak of the pandemic, Zoom's stock surged in value. Granted, it has an easy-to-use app for videoconferencing, but for that to drive the company to a market cap of around $160 billion is incomprehensible to me.
The company beat earnings expectations last quarter, but that's hardly anything to get excited about. Despite its fall from grace over the past few years, Zoom is still a risky stock and one that you should think twice about owning.
Its earnings beat was on an adjusted basis
When Zoom reported earnings in February, the big news was its massive earnings beat, with adjusted earnings per share (EPS) of $1.22 for the period ending Jan. 31 soundly beating analyst expectations, which called for an adjusted EPS of only $0.81.
But these are adjusted earnings numbers. The company effectively transformed a net loss of $104.1 million into an adjusted earnings profit of $366.6 million for the quarter, and here's how:
|Metric||Value (in thousands)|
|Stock-based compensation and related payroll taxes||$520,951|
|Gains on strategic investments||($40,443)|
|Tax effects on adjustments||($23,672)|
The big item that stands out is stock-based compensation of just under $521 million. These were expenses for the company, but because it paid them out as stock rather than cash, it removed this from its adjusted earnings calculation.
But the reality is that's still an expense for the business, and diluting shareholders through stock-based expenses isn't a whole lot better than spending cash on those costs.
Cash flow also paints a troubling picture
Another problem is that the company's operating cash flow has been going in the wrong direction.
While investors will note that the cash flow is technically positive, here, too, stock-based compensation is making the business look better than it is since, again, it's not a cash-based expense, so the operating cash flow figure excludes that outflow.
Thanks to stock-based compensation, Zoom has turned a loss into an (adjusted) profit, which helped it avoid burning through cash. It potentially paints a misleading picture of the business. But as concerning as these items are, they still aren't Zoom's biggest problems.
Sales look to be stalling
The most important number for Zoom investors should be sales, as the company's top line is struggling to generate positive growth of late and that's a concerning sign.
ZM Revenue (Quarterly YoY Growth) data by YCharts
Convincing customers to pay for videoconferencing is going to be a challenge amid the current economic challenges. That's because not only is it expensive (hundreds of dollars per year), but Microsoft already offers its Teams videoconferencing software within Office 365 -- which many businesses use. Trying to convince customers to buy a subscription for a capability that many of them may already have access to is going to be a big test for the company, especially as companies look to cut costs with a potential recession looming.
The stock looks overpriced for what it offers
Zoom has branched out into offering other services, such as a contact center and virtual receptionist, but its core business still centers around videoconferencing, and that's a problem. Zoom will potentially need to spend more on sales and marketing to keep and grow its customer base, which is why I'm not optimistic the business will get better in the future.
The company is facing some serious risks. With no competitive advantage, diminishing cash flow, and minimal sales growth, this is a tech stock that could continue to decline as the year goes on because even at $20 billion, its market cap looks incredibly high.