Professional money managers handle billions of dollars in client funds, putting immense pressure on them to perform. Cathie Wood's innovation-focused firm ARK Invest is no exception.
The company's flagship fund, the ARK Innovation ETF, holds over $8 billion in assets. Cathie Wood has placed a big bet on Zoom Video Communications (ZM 1.57%). It's the fund's fifth-largest holding at 7.1%, a position worth nearly $600 million.
ARK believes the stock can hit $1,500 by 2026. However, the stock trades at about $71 as of this writing, down 88% from its all-time high. So, does Cathie Wood's ultra bullish outlook make the stock a buy?
Here's what you need to know.
Stellar bottom-line growth is on the way
Zoom was a stock market darling during the early months of the pandemic. The company experienced a surge of growth when virtually the entire world moved to video calls to communicate during lockdowns. At its peak -- the end of fiscal 2021 -- Zoom grew revenue 369% year over year.
But that also pulled forward years of potential growth, leaving Zoom struggling to sustain its momentum as the pandemic faded. Most recently, revenue grew just 3.2% in its fiscal 2024 third quarter. That slowdown is largely why the stock has fallen so far.
However, the massive expansion of Zoom's business is creating stellar earnings growth thanks to operating leverage (when revenue grows faster than expenses). The company has made over $1.3 billion in cash profits over the past year, and there is now $6.5 billion in cash on the balance sheet, nearly 30% of Zoom's market cap.
Data by YCharts.
Analysts believe Zoom's earnings per share (EPS) could compound at 38% annually, potentially setting up fantastic investment returns. We'll revisit this subject in a minute.
Why Zoom's revenue growth could pick up again
Zoom has built up an impressive base of 219,700 enterprise customers. There's potential growth in upselling these customers with some of Zoom's new products, which include:
- Zoom Phone: a cloud-based business telephone system
- Zoom Contact Center: digital contact centers with video capability
- Zoom One: an all-in-one package of communications and collaboration tools
There is early traction with these offerings. Zoom Contact Center customers grew to 700 as of the latest quarter, and the number of Zoom One customers signing up for Zoom Phone increased more than 300% year over year.
Not every enterprise customer needs a contact center, but even a modest conversion rate on nearly 220,000 accounts would be a big boost, and Zoom is still picking up new accounts at a solid clip. There are millions of businesses across the world.
Zoom's enterprise customer base increased 5% year over year in the fiscal third quarter with a 105% net revenue retention rate. I don't expect Zoom to grow at high double-digit rates again, but revenue growing 10% or more annually looks realistic.
Wonderful investment returns? Here's how
There are two primary factors in investment returns: a company's growth and how much you paid for that growth. The market's bearish view of the stock has pushed shares down to a forward P/E ratio of just 15. For a company that's expected to grow earnings by more than 37% annually, that's a tremendous discount. You typically want to see a PEG ratio below one, and Zoom's is 0.40.
Data by YCharts.
Investors can easily see Zoom's potential with some math. Suppose Zoom grows earnings 25% annually (lower than the analysts' expectation) for the next five years. That would grow EPS to roughly $15 per share by year five, or 2028. That sustained growth should drive the stock's P/E ratio higher as well.
A P/E of 25, for example, on $15 in earnings per share would result in a share price of $375, or a five-year return of over 400% from current levels. Zoom can be a winning investment, even if it doesn't reach the lofty targets ARK Invest has put on it.
A lot would need to go wrong for Zoom to disappoint investors from here on out. Cathie Wood feels confident enough to bet $600 million on the company.
