Zoom Video Communications (ZM 1.10%) has a lot of the attributes investors look for in a great stock pick. The company's video tools gained a huge number of users during the pandemic, and the business became massive. With just over $4.5 billion in revenue expected for fiscal 2024 (ended Jan. 31), it's on track to deliver nearly $5 in adjusted earnings per share for the year.
But something doesn't quite smell right here. Wall Street isn't giving the stock much love as shares trade at a bargain valuation despite sitting on a massive cash pile, equivalent to about a third of its market cap.
So is Zoom stock a bargain that Wall Street doesn't yet appreciate, or are there good reasons why investors are discounting it? There are arguments to be made on both sides.
NASDAQ: ZM
Key Data Points
The bull case for Zoom
The company sells digital communications solutions, including video, chat, and meeting rooms worldwide. Understandably, its business took off during the pandemic when social-distancing efforts and lockdowns largely prevented people from meeting in person. The company had a remarkable growth spurt in 2020.
What's also impressive is that Zoom retained that growth as social-distancing requirements eased. That left Zoom in a fantastic financial position. The business booked $1.3 billion in trailing-12-month free cash flow, giving it a 29% margin. Additionally, Zoom is sitting on $6.5 billion in cash and marketable securities with zero debt.
Data by YCharts.
The stock's price-to-earnings ratio is only 13.2 based on its expected fiscal 2024 earnings, and it won't take much to drive strong returns. Heck, Zoom could repurchase a third of its outstanding shares with the cash on its balance sheet. It's not often you find such a profitable and well-funded technology business trading at such a low valuation.
The bear case
Admittedly, Zoom is a healthy business, at least financially. But investors value growth, and that's where Zoom is having problems. The pandemic appears to have pulled forward a ton of its demand, as evidenced by the company's slide to a low-single-digit revenue growth rate in recent quarters.
Additionally, Zoom is seeing some key metrics deteriorate, including its enterprise customer growth and the net dollar expansion rate for enterprise customers.
| Quarter | Enterprise Customer Growth (YOY) | TTM Net Dollar Expansion Rate for Enterprise Customers |
|---|---|---|
| Q4 fiscal 2022 | 35% | 130% |
| Q1 fiscal 2023 | 24% | 123% |
| Q2 fiscal 2023 | 18% | 120% |
| Q3 fiscal 2023 | 14% | 117% |
| Q4 fiscal 2023 | 12% | 115% |
| Q1 fiscal 2024 | 9% | 112% |
| Q2 fiscal 2024 | 7% | 109% |
| Q3 fiscal 2024 | 5% | 105% |
Data source: Zoom Video Communications. Zoom's fiscal years end on Jan. 31 of the corresponding calendar year. YOY = year over year. TTM = trailing 12 months.
These trends illustrate two problems. First, Zoom is picking up fewer new customers. Second, the spending growth of its existing customer base is slowing over time.
Even more troubling is that Zoom has dramatically ramped up its spending on sales and marketing, which feels like paddling upriver with a spoon. It's spending a lot of money without much growth to show for it.
Data by YCharts.
This may not be a short-term problem. After all, Zoom operates in an industry with steep competition from companies like Microsoft and Alphabet. The transition period coming out of the pandemic has been challenging for many companies, but it's possible Zoom's growth will accelerate again as businesses continue going digital.
What should investors do?
This question doesn't have a clear answer, which probably explains why the market has hesitated to embrace the stock. Zoom has evolved its business to include more than video conferencing. Zoom One is an all-in-one collaboration platform, and enterprises can now create and operate cloud-based contact centers through Zoom's platform. The company has also implemented artificial intelligence (AI) to do things like automatically generate meeting notes from Zoom calls.
The good news is that Zoom has a hefty margin of safety at its current valuation, so those who believe in the company's potential can feel a bit better about buying the stock today. But for the stock to be a smashing success, Zoom will have to prove to investors that its core business still has room for growth.
