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There’s a Big Problem With Zoom Stock

While the stock market has tumbled over the past month as the novel coronavirus outbreak shifted from something happening in China to a global pandemic, certain stocks have bucked the trend. Zoom Video Communications (NASDAQ: ZM), a provider of subscription-based video conference software, is one of them. Since the start of 2020, Zoom stock has more than doubled, while the S&P 500 is down nearly 25%.

The story behind Zoom's outperformance makes a lot of sense. As businesses, schools, and other organizations require employees to work remotely amid the pandemic, demand for video-conferencing capabilities is surging. Zoom was already growing quickly before the pandemic, with revenue up 88% in fiscal 2020. That growth rate will now almost certainly accelerate, at least for a while.

Zoom was also profitable on a GAAP basis last year, a rarity among fast-growing software-as-a-service companies. It's hard to claim that Zoom isn't a great company, given its results.

But great companies aren't always great investments. At the wrong price, the best company in the world will provide investors with abysmal returns. Quality matters, but price matters, too.

For Zoom, the price is very wrong.

Image source: Zoom.

Detached from reality

In Zoom's pre-IPO S-1 filing, the company claimed that its total addressable market would reach $43.1 billion by 2022. This number was based on estimates from IDC for various portions of the communication and collaboration market. Zoom claimed that it addressed the hosted/cloud voice and unified communications, collaborative-applications, and IP telephony lines segments.

If there's one thing you can be sure of in an S-1 filing for any hot company, it's that the total addressable market is being inflated as much as possible. The collaborative-applications segment, for example, includes all sorts of stuff that Zoom has no part in, like cloud-based productivity software.

Zoom is not the worst offender by a long shot. Fake-meat company Beyond Meat claimed it addressed the entire $1.4 trillion global meat industry. Foam-mattress provider Casper Sleep pointed to a $432 billion market opportunity that encompassed everything even tangentially related to sleep.

Still, Zoom is probably overestimating the opportunity. The video-conferencing market itself was worth just over $6 billion in 2019, according to Transparency Market Research, and it's expected to grow by just 8.4% annually from 2020 to 2027.

To put these numbers into context, Zoom is currently valued just below $40 billion. In other words, the company's market capitalization is nearly as large as its (likely inflated) total addressable market in 2022, and more than six times as large as the video-conferencing market today.

You could argue that the pandemic will accelerate video conferencing adoption, but the valuation makes no sense relative to the company's market opportunity.

Relative to sales, Zoom stock is also exceptionally expensive. The company generated revenue of $622.7 in fiscal 2020, putting the price-to-sales ratio at nearly 64. That ratio is much lower if you use expected sales for the current year, but it's still in the dozens.

Zoom is one of the few stocks soaring this year. The story behind the company is compelling. The company will probably continue to do well, even after the pandemic ends and it loses some of its new customers. But the stock is a disaster waiting to happen.

Find out why Zoom Video Communications is one of the 10 best stocks to buy now

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Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Zoom Video Communications and recommends the following options: short May 2020 $120 calls on Zoom Video Communications. The Motley Fool has a disclosure policy.


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