Zoom has been on fire lately. In the past six months alone, the company’s stock price has rocketed 56%, reaching $86.90 per share. This was partly thanks to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Zoom, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.
We’re glad investors have benefited from the price increase, but we're sitting this one out for now. Here are three reasons why ZM doesn't excite us and a stock we'd rather own.
Why Is Zoom Not Exciting?
Started by Eric Yuan who once ran engineering for Cisco’s video conferencing business, Zoom (NASDAQ:ZM) offers an easy to use, cloud-based platform for video conferencing, audio conferencing and screen sharing.
1. Weak ARR Points to Soft Demand
While reported revenue for a software company can include low-margin items like implementation fees, annual recurring revenue (ARR) is a sum of the next 12 months of contracted revenue purely from software subscriptions, or the high-margin, predictable revenue streams that make SaaS businesses so valuable.
Zoom’s ARR came in at $4.71 billion in Q3, and over the last four quarters, its year-on-year growth averaged 2.9%. This performance was underwhelming and suggests that increasing competition is causing challenges in securing longer-term commitments. 
2. Projected Revenue Growth Is Slim
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect Zoom’s revenue to rise by 2.8%, a slight deceleration versus its 5.8% annualized growth for the past three years. This projection doesn't excite us and suggests its products and services will face some demand challenges.
3. Cash Flow Margin Set to Decline
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Over the next year, analysts predict Zoom’s cash conversion will fall. Their consensus estimates imply its free cash flow margin of 37.3% for the last 12 months will decrease to 33%.
Final Judgment
Zoom isn’t a terrible business, but it isn’t one of our picks. Following the recent surge, the stock trades at 5.7× forward price-to-sales (or $86.90 per share). Beauty is in the eye of the beholder, but we don’t really see a big opportunity at the moment. We're fairly confident there are better stocks to buy right now. We’d suggest looking at the most dominant software business in the world.
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