Zoom Video Communications' (ZM 1.57%) business was among the biggest beneficiaries of early pandemic demand changes. Its video communications platform became essential at a time when in-person meetings just weren't possible. Its annual sales soared to over $4 billion last year from around $700 million in 2019.
Those high-growth days are over now. Most Wall Street pros expect Zoom's sales to fall slightly this fiscal year, in fact. But smart investors know that it pays to look beyond short-term fluctuations and focus on a company's broader potential.
So let's review three reasons smart investors should be cautiously optimistic about this software-as-a-service specialist.
1. Shifting dynamics point to potential new growth
Zoom executives have known for some time that they couldn't rely on the same growth factors that had propelled the business to over $4 billion of annual sales in 2022. That's why they've been pivoting toward innovating for enterprises over prioritizing sales to consumers. Zoom made huge progress on this front already. Sales in its enterprise segment were $660 million last quarter, which amounts to roughly 58% of total revenue.
It's not hard to see why Zoom is targeting this niche. Demand is strong among enterprises seeking efficient and productive communication services and flexibility for remote work. The enterprise division grew at a double-digit rate last quarter while Zoom's online, consumer-focused segment shrank by 4%. These trends combined to create a 5% sales uptick in fiscal Q2, but the enterprise segment will increasingly drive overall results.
2. Smart spending means plenty of resources to draw on
While some pandemic winners overextended themselves during the high-growth days, Zoom took a different approach. Management remained cautious about committing to much higher infrastructure spending, and so the company has been able to avoid the type of intense cost cuts that characterized Meta Platform's early 2023.
ZM Operating Margin (TTM) data by YCharts
It's true that Zoom's profit margin chart looks terrifying, with operating income rising to 24% of sales in 2021 before collapsing back down to the low single digits in the following 18 months. But look at cash production and you'll see more reasons to be bullish. Annual operating cash flow is holding relatively stable at nearly $1.5 billion. Zoom is sitting on $6 billion of cash today, too, compared to its $18 billion market capitalization.
These resources help protect investors worried about big financial losses. They also provide management with the flexibility to invest in growth initiatives at a time when many rivals might be focused on cost cuts and restructuring.
3. Watching for a rebound
Zoom stock is valued at a discount that reflects some serious investor concerns about its growth prospects. Sure, enterprise clients are engaged with its platform and are renewing contracts at higher annual rates. But there are many competitors in this space also jockeying for market share. Some of them, like Microsoft, offer much more comprehensive solutions to clients.
That's why it will be key to watch Zoom's enterprise segment over the next few quarters. If the company can accelerate growth there, then it will reinforce management's wider rebound plan. It will also validate its recent moves to pour money into expanding the platform portfolio, including through acquisitions.
But to date, there's little evidence to show that Zoom can dominate in the enterprise market at anything approaching the level that it once did in the consumer niche. Until that evidence arrives, smart investors might want to simply watch this software stock for now.
