Why Zoom Communications Is Still a Sizzling Hot Trade



a sign on the side of a building: zoom (ZM) logo on a building


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zoom (ZM) logo on a building

There is no end in sight to the ongoing pandemic, especially in the United States. Even if daily infection rates fall, the flu season and the cold weather will drive people to stay indoors more often, causing the virus to spread more quickly. To mitigate the virus’ spread, companies will continue to have their employees work from home if at all possible. As schools re-open, small outbreaks among students will increase the need for remote teaching. As a result of these trends,  Zoom Communications’ (NASDAQ:ZM) subscriptions will rise, providing a positive catalyst for ZM stock.



a sign on the side of a building: zoom (ZM) logo on a building


© Provided by InvestorPlace
zoom (ZM) logo on a building

Recently, the shares reached a new high of $302, and their trailing price-earnings ratio now exceeds 1,700. But, anticipating a sharp increase in Zoom’s revenue and profits, driven by higher demand in many facets of society,  markets are pricing in the company’s future value.

More Video Meetings

The number of Zoom’s corporate customers that had more than ten  employees soared 354% in the first quarter.  Overall usage of the system increased impressively.

For example, the peak number of daily meeting participants (including those who are paying for the service and those who are not) soared by 300 million, and the company often benefited from similar user-growth levels.

On the company’s Q1 earnings conference call, Zoom CEO Eric Yuan reported that individuals who join multiple meetings in a day are counted as multiple users. For example, he noted that an individual who joins five meetings in one day on Zoom would be counted as five separate users.

But investors cannot deny that the company looks poised to generate very strong revenue growth. Zoom’s sales soared 169% year-over-year to $328 million amid the growing demand for its service by companies and organizations. At the end of Q1, the number of Zoom’s customers that were  generating over $100,000 of annual recurring revenue had jumped by 500 year-over-year.

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Higher Costs

In Q1, Zoom gave a one-time bonus to its employees who are not paid based on commissions. As a result,  Zoom will benefit from higher staff satisfaction.

Also pushing up the company’s costs was its increased use of  the public cloud. Its leverage of the cloud allowed it to increase its capacity and meet unprecedented demand. As it increases the capacity of its own data centers, its costs per user will drop, lifting its gross margin back to the mid-70% range within a few quarters.

Zoom’s research and development costs rose 66% year-over-year to $21 million. With ZM stock continuing to climb, shareholders are rewarding the company for investing in its business.

But Zoom needs to make its product more secure. In consultation with top IT security firms, it must develop ways of protecting its customers from eavesdroppers.

Outlook

Zoom forecast non-GAAP earnings per share of $1.21 – $1.29, so its forward P/E ratio is over 230 times Based on the five-year discounted cash-flow-revenue-exit model below,  ZM stock has a fair value of over $400:

Metrics Range Conclusion Discount Rate 12.0% – 10.0% 11.00% Terminal Revenue Multiple 15.0x – 10.0x 12.0x Fair Value $501.48 – $368.34 $421.12

The data was obtained from finbox.

The average price target of Wall street analysts is bearish, coming in at under $240.00, according to  Tipranks. That price target might be justified if investors cared more about valuations at this point.

But it is important to note that the launch of a coronavirus vaccine would slow the work- from-home trend. Also, a permanent drop in new infections in the U.S. would cause the current restrictions on business travel and offices to ease. Both of theevents would hurt Zoom’s profitability.

The Bottom Line

Zoom is at the heart of online communications. Despite competing video-chat options from Cisco’s (NASDAQ:CSCO) Webex and Microsoft’s (NASDAQ:MSFT) Teams, Zoom has become a household name. Its high brand recognition gives it an edge over the competition.

The valuation of ZM stock is unfavorable, but the shares are still compelling for traders.

As of this writing, the author did not hold a position in any of the aforementioned securities.

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