Software company Zoom Video Communications stunned Wall Street today as it surged to $74.44, marking a 3.0% change. ZM is -10.88% below its average analyst target price of $83.53, which implies there is more upside for the stock. However, the average analayst rating for the stock is hold -- a more pessimistic outlook than you might expect. Over the last year, Zoom Video Communications has underperfomed the S&P 500 by 4753.0%, moving -3250.5%.
Zoom Video Communications, Inc. provides unified communications platform in the Americas, the Asia Pacific, Europe, the Middle East, and Africa. The companyis in the technology sector, which groups together a wide range of industries including consumer electronics, software, computer hardware, scientific instruments and IT services. Legendary investor Warren Buffet once stated that he would never invest in technology companies. Apple is now one of his largest holdings.
The risks inherent to the technology sector are clear, but investors simply cannot ignore the potential for strong returns. Even with the lessons learnt in the 2000 tech bubble, the market continues to highly value the promise of technological innovation and the ability for these companies to build and occupy new markets.
Zoom Video Communications's trailing 12 month P/E ratio is 3722.0, based on its trailing EPS of $0.02. The company has a forward P/E ratio of 17.0 according to its forward EPS of $4.38 -- which is an estimate of what its earnings will look like in the next quarter. As of the first quarter of 2023, the average Price to Earnings (P/E) ratio of US technology companies is 27.16, and the S&P 500 average is 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (EPS), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.
Zoom Video Communications's P/E ratio tells us how much investors are willing to pay for each dollar of the company's earnings. The problem with this metric is that it doesn't take into account the expected growth in earnings of the stock. Sometimes elevated P/E ratios can be justified by equally elevated growth expectations.
We can solve this inconsistency by dividing the company's trailing P/E ratio by its five year earnings growth estimate, which in this case gives us a -35.7 Price to Earnings Growth (PEG) ratio. In ZM's case, the elevated P/E ratio is justified by future earnings growth estimates -- assuming those estimates turn out to be close to reality.
To better understand the strength of Zoom Video Communications's business, we can analyse its operating margins, which are its revenues minus its operating costs. Consistently strong margins backed by a positive trend can signal that a company is on track to deliver returns for its shareholders. Here's the operating margin statistics for the last four years:
| Date Reported | Total Revenue ($ k) | Operating Expenses ($ k) | Operating Margins (%) | YoY Growth (%) |
|---|---|---|---|---|
| 2023-01-31 | 4,392,960 | 3,047,080 | 5.59 | -78.45 |
| 2022-01-31 | 4,099,864 | 1,981,719 | 25.94 | 4.22 |
| 2021-01-31 | 2,651,368 | 1,169,531 | 24.89 | 1120.1 |
| 2020-01-31 | 622,658 | 494,566 | 2.04 | n/a |
- Average operating margins: 14.6 %
- Average operating margins growth rate: 28.7 %
- Coefficient of variability (lower numbers indicate less volatility): 86.0 %
Another key to assessing a company's health is to look at its free cash flow, which is calculated on the basis of its total cash flow from operating activities minus its capital expenditures. Capital expenditures are the costs of maintaining fixed assets such as land, buildings, and equipment. From Zoom Video Communications's last four annual reports, we are able to obtain the following rundown of its free cash flow:
| Date Reported | Cash Flow from Operations ($ k) | Capital expenditures ($ k) | Free Cashflow ($ k) | YoY Growth (%) |
|---|---|---|---|---|
| 2023-01-31 | 1,290,262 | -115,094 | 1,175,168 | -19.49 |
| 2022-01-31 | 1,605,266 | -145,608 | 1,459,658 | 5.36 |
| 2021-01-31 | 1,471,177 | -85,815 | 1,385,362 | 1118.79 |
| 2020-01-31 | 151,892 | -38,225 | 113,667 | n/a |
- Average free cash flow: $1.03 Billion
- Average free cash flow growth rate: 79.3 %
- Coefficient of variability (the lower the better): 60.5 %
Free cash flows represents the amount of money that is available for reinvesting in the business, or paying out to investors in the form of a dividend. With a positive cash flow as of the last fiscal year, ZM is in a position to do either -- which can encourage more investors to place their capital in the company.
Value investors often analyze stocks through the lens of its Price to Book (P/B) Ratio (its share price divided by its book value). As of the first quarter of 2023, the mean P/B ratio of the technology sector is 6.23, compared to the S&P 500 average of 2.95. The book value refers to the present value of the company if the company were to sell off all of its assets and pay all of its debts today - a number whose value may differ significantly depending on the accounting method. Zoom Video Communications's P/B ratio is 3.39, indicating that the market value of the company exceeds its book value by a factor of more than3, but is still below the average P/B ratio of the Technology sector.
As of first quarter of 2023, Zoom Video Communications is likely overvalued because it has an inflated P/E ratio, a lower P/B ratio than its sector average, and generally positive cash flows that are on an upwards course. The stock has poor growth indicators because of its weak operating margins with a positive growth rate, and an inflated PEG ratio. We hope this analysis will inspire you to do your own research into ZM's fundamental values -- especially their trends over time.
