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3 Things About Zoom That Smart Investors Know

Motley Fool - Fri Aug 25, 6:43AM CDT

Even widely followed stocks tend to surprise Wall Street analysts from time to time. Short-term growth projections are imprecise, to say the least, and demand trends are always shifting due to things like economic factors, competitive pressures, and corporate strategies.

But there are some things investors can feel confident about regarding a tech business like Zoom(NASDAQ: ZM). Let's look at three of these concrete factors that drive long-term returns for this tech communications specialist.

1. A new kind of growth

Zoom's annual sales were close to $600 million before the pandemic struck and then quickly shot up to over $4 billion. But that demand surge is over now that social distancing efforts have ended. Growth in 2023 is likely to be around 2%, in fact, compared to 7% last year and 55% in fiscal 2022.

Smart investors know that the business isn't done expanding, though. Zoom said in mid-August that declines in its online business slowed to 4% in Q2, in part because cancellation rates improved. Zoom's bigger target is businesses, though, which are increasingly signing up for its communication platform.

Its enterprise division grew 10% last quarter and accounted for 58% of sales, up from 54% a year ago. Management's goal right now is to get the online business stabilized while leaning into that corporate platform.

2. Financial stability

While Zoom's demand rebound is still speculative, its financial strength is more concrete. While earnings contracted, the company remained profitable through the entire growth hangover following the pandemic.

Operating margin is finally improving again, too. That figure rose to $178 million this past quarter from $122 million a year ago. Non-GAAP earnings rose to 41% of sales in Q2, compared to 36% of sales a year earlier. That boost occurred despite higher spending on research and development.

ZM Free Cash Flow Chart

ZM Free Cash Flow data by YCharts.

Cash trends tell a similarly positive story. After declining in 2022, free cash flow jumped 26% this quarter to cross 25% of sales. That's a more instructive metric for investors to follow than revenue, given the fact that Zoom books most of its sales over time. The company is sitting on lots of cash, too, at $6 billion, as of late July.

3. Patience is key

Zoom's updated outlook still implies close to zero growth this year, meaning investors will need to be patient as they wait for concrete signs of accelerating demand for both the online and enterprise platforms.

The good news is that Zoom's stock price reflects that uncertainty. You can own shares today for about 4x annual sales, down from a price-to-sales ratio of 7 a year ago. If you're more risk averse, you might want to simply watch the stock for a few quarters as clarity develops around its rebound strategy.

On the other hand, the best returns will likely come from purchases made during this period of low enthusiasm around its business -- assuming Zoom has the right growth strategy in place.

In the meantime, watch key metrics, like customer additions and cash flow. If these continue trending in the right direction, Zoom's stock could be a positive addition to your portfolio over the long term.

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Demitri Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Zoom Video Communications. The Motley Fool has a disclosure policy.

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