Zoom’s Inflated Valuation Has Burst

Last fall, I checked on the shares of videoconferencing company Zoom Video Communications (Nasdaq: ZM) and gave them a blunt assessment:

I most definitely wish I had owned shares of Zoom on January 1 and held through today…

But if I did, I can tell you the first thing I would do…

I would sell them. Immediately.

In hindsight, we know that selling Zoom last fall was definitely the right call.

As of now, Zoom shares are down 40% from last October.

That’s bad for anyone who owned Zoom shares since then.

Even worse, while Zoom’s shares have suffered mightily, the S&P 500 has soared by 30%.

Relative to the market, Zoom’s shares have underperformed by a whopping 70%.

Putting this underperformance in terms of dollars doesn’t alleviate the pain.

To my eyes, it makes it look worse.

While a $10,000 investment made in the S&P 500 last fall is now worth more than $13,000…

A similar $10,000 investment in Zoom has declined in value to less than $6,000.

It Wasn’t the Business… It Was the Price

My bearishness on Zoom had nothing to do with the quality of the business.

In fact, I was and still am quite impressed with what Zoom offers its customers and how its business is performing.

My problem with Zoom last fall was that the stock market had valued the company far too generously.

Zoom’s total market capitalization (share price multiplied by the number of shares outstanding) had reached a massive $160 billion.

For a company that went on to post total net income of $672 million in 2020, a $160 billion valuation is really, really high.

For perspective, consider that if you bought the entire company for that $160 billion valuation, you would be locking in a 2020 earnings yield of 0.42% ($672 million of earnings / $160 billion price).

Earnings yield is an inverted view of the more common price-to-earnings ratio, which, at that $160 billion valuation, was a lopsided 238-to-1.

Additional perspective can be gained by comparing Zoom with other companies valued similarly by the stock market.

Included on that list are behemoths valued around the $160 billion Zoom carried last fall, along with their posted 2020 earnings:

• Philip Morris (NYSE: PM), which had $8 billion in earnings
• Citigroup (NYSE: C), which had $11 billion in earnings
• Texas Instruments (Nasdaq: TXN), which had $5.5 billion in earnings.

Zoom, with $672 million in earnings, was carrying a valuation similar to these companies, which earn exponentially more money.

Now, valuation must be considered relative to how fast a company is growing earnings and cash flows.

Fast-growing companies can be incredible investments.

There is no question that Zoom was and still is a fast-growing business.

The problem I saw with Zoom’s growth last fall was that it was unsustainable – eventually stay-at-home conditions related to COVID-19 were going to pass or slacken.

It’s no wonder that the collapse in Zoom’s share price coincided with the major announcements of the success of COVID-19 vaccines.

A light at the end of the pandemic tunnel was bad news for Zoom.

Good investing,

Jody