top partner

for CFD

Pandemic-era phenom Zoom (NASDAQ: ZM) is slowly turning itself around after the work-from-home tailwind that drove incredible growth in 2020 and 2021 largely vanished. Revenue grew by 3.6% year over year in the second quarter, driven by a 10.2% rise in enterprise revenue, and profitability improved dramatically. Enterprise revenue now accounts for about 58% of total revenue as the company reduces its dependence on the more volatile self-serve channel.

Thanks to layoffs earlier this year and other cost-cutting measures, Zoom has brought its bottom line back up to healthy levels. Zoom’s GAAP operating margin came in at 15.6% in the second quarter, up from 11.1% in the prior-year period. The company produced GAAP net income of $182 million on $1.14 billion of revenue.

An enormous gap

That’s solid progress, but it’s not enough to justify Zoom’s stock price. Even though shares of Zoom are down a whopping 88% from their all-time high, it still requires quite a bit of optimism to justify the valuation. If you take Zoom’s second-quarter net income and annualize it, you get a price-to-earnings ratio of about 27. For a company that’s barely growing at all, that seems pricey.

The story is wildly different if you look at one of Zoom’s non-GAAP profit metrics instead. Zoom expects its non-GAAP net income in the current fiscal year to be about double the net income figure I used for the previous calculation. If you take this non-GAAP metric at face value, Zoom’s price-to-earnings ratio falls to a more attractive 14.

Free cash flow also looks a lot better. Taking Zoom’s free cash flow through the first six months of the fiscal year and doubling it, Zoom stock trades at a price-to-free-cash-flow ratio of about 15. All you need to do to justify that valuation is assume that Zoom will accelerate its growth modestly as it emerges from its post-pandemic malaise.

There’s a problem with both non-GAAP net income and free cash flow: Neither is a good representation of Zoom’s true profitability. GAAP net income is far from a perfect measure, but at least that metric doesn’t ignore real costs. The profitability metrics that make Zoom stock look reasonably priced take stock-based compensation, critical for retaining talented employees, and disregard it entirely.

A real cost

Zoom booked $261.5 million in stock-based compensation costs during the second quarter, up slightly from the prior year period despite the company laying off 15% of its workforce earlier this year. Stock-based compensation isn’t a cash cost, but it is a real cost. If Zoom suddenly stopped handing out equity awards, it would need to ramp up cash compensation to keep employees from fleeing.

It’s also a very real cost imposed on shareholders. Stock-based compensation increases the share count, thus diluting the company’s profit across more shares. A shareholder owns less of a company with each passing quarter as that company doles out stock-based compensation.

Zoom has used share buybacks to offset the dilution from stock-based compensation. Although the company has stopped buyback activity over the past six months, it spent enough buying back its own shares in the second half of 2022 to keep its share count in check. Zoom’s outstanding share count was approximately unchanged in the second quarter compared to the prior-year period.

What this means is that Zoom’s non-GAAP metrics ignore stock-based compensation as an expense while the company doles out cash to eliminate the negative impact of that stock-based compensation. Zoom spent $1 billion on share buybacks in fiscal 2023, wiping out nearly all of the company’s free cash flow.

None of this is unique to Zoom. There are plenty of tech companies that do exactly the same thing. But the gap between Zoom’s GAAP and non-GAAP profit metrics is exceptionally large. Before you consider investing in Zoom stock, make sure you understand what the company’s adjusted profitability metrics really represent.

10 stocks we like better than Zoom Video Communications
When our analyst team has a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

They just revealed what they believe are the ten best stocks for investors to buy right now… and Zoom Video Communications wasn’t one of them! That’s right — they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of August 21, 2023

Timothy Green 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.

Read the full story: Read More“>

Blog powered by G6

Disclaimer! A guest author has made this post. G6 has not checked the post. its content and attachments and under no circumstances will G6 be held responsible or liable in any way for any claims, damages, losses, expenses, costs or liabilities whatsoever (including, without limitation, any direct or indirect damages for loss of profits, business interruption or loss of information) resulting or arising directly or indirectly from your use of or inability to use this website or any websites linked to it, or from your reliance on the information and material on this website, even if the G6 has been advised of the possibility of such damages in advance.

For any inquiries, please contact [email protected]