Zoom’s business has 1 glaring problem
Zoom video communication (ZM 0.52%) was one of the hottest stocks in the early stages of the pandemic as video conferencing software made remote working and social distancing much easier. Now, however, amid a return to normalcy in the economy, the stock has struggled badly. It’s down 76% over the past year (the S&P500 is down just 11% over that stretch) and it has given back all of its gains and is trading back to where it was in early 2020.
It might be tempting to buy the stock near its 52-week low, but investors should consider serious risk before doing so.
The company lacks a moat
A moat is a defensible competitive advantage that allows a company to perform well and keeps its investors from taking too much market share. Zoom is a great example of a company without much moat.
While Zoom’s sales have skyrocketed in recent years, it didn’t make sense to me that so many companies were buying its services when they likely already had video conferencing capabilities of their own. Video conferencing is by no means a new phenomenon, but Zoom has made it popular and easier to use — people just have to click a link to join a virtual meeting.
However, these are not benefits that can last long. Many technology companies have since expanded their video conferencing capabilities. For example, Microsoft‘s (MSFT -0.85%) The team software facilitates collaboration and group chat and now also enables fast video conferences. In Windows 10, used by more than 1 billion devices each month, the company even added a “Meet Now” button so users can easily access the company’s Skype video conferencing capabilities.
With a huge install base of its operating system, Microsoft has a major advantage over Zoom: Microsoft Teams is already included in the Microsoft 365 suite, which gives users access to popular Office apps like Word, Excel, and PowerPoint.
Other companies also offer video conferencing software, and preference and cost can determine which brand consumers and businesses choose. That could result in intense competition for Zoom at a time when it’s already struggling to generate growth.
Zoom’s finances could take a hit
On Aug. 22, Zoom released its second-quarter results, which weren’t all that impressive. Revenue of just under $1.1 billion for the period ended July 31 grew at a relatively modest rate of 8% year over year. That’s a sharp drop from the company’s rapid growth in the past:
For the third quarter, the company expects its earnings to be flat and show no growth from the end of the second quarter. Over the longer term, as companies look to cut costs in the face of rising inflation, getting rid of a video conferencing service that costs hundreds of dollars per user per year could be an easy way to cut costs, leading to weaker numbers for Zoom later on would.
Zoom has a bit of wiggle room, as right now its gross margins are healthy at around 75% of sales, so it could cut its fees a bit. But price cuts that are too aggressive could push profits into the red because operating margin isn’t as strong as it used to be:
Is Zoom stock too expensive?
Zoom shares are trading near their 52-week low. At a forward price-to-earnings (P/E) ratio of 22, the stock trades in line with the average stock for the year Technology Select Sector SPDR Fund.
But given the challenges the company is facing and potentially narrowing margins when it comes to attracting new customers, its profits could deteriorate. Because of this, I’d argue that Zoom belongs at a lower future earnings multiple and isn’t necessarily a bargain, despite trading at a much lower valuation than it did a year ago.
It’s a challenging time for Zoom, as the company needs to prove it can generate strong growth numbers to justify its premium. I’m not confident that this can be done without significant price concessions. And because of that, I’d avoid this growth stock for now as its shares could fall even further.
David Jagielski does not hold any of the shares mentioned. The Motley Fool has positions in and recommends Microsoft and Zoom Video Communications. The Motley Fool has a disclosure policy.
#Zooms #business #glaring #problem Source