Since the beginning of the Covid-19 pandemic, several sectors have grabbed the limelight. In particular, due to the advent of social distancing, online businesses flourished. Zoom (NASDAQ:ZM), which provides a video-communications platform, was a major beneficiary of the trend, causing ZM stock to boom.
Trading at $67 towards the end of 2019. the stock skyrocketed to highs of $559 in October 2020. Lately, however, ZM stock has been trending lower. Currently, it trades around $280.
Some might be tempted to consider obtaining exposure to the stock after its meaningful correction. However, it’s worth noting that ZM stock still trades at a forward price-earnings-ratio of 57.1.
For high-growth companies, P/E ratio might not be the best valuation indicator. So let’s talk about Zoom’s price-earnings-to-growth-ratio (PEG Ratio). According to analysts’ mean estimates, Zoom Video’s earnings growth is likely to average 20.8% for the next five years. That indicates that the shares have a PEG ratio of 2.76, suggesting that ZM stock is clearly overvalued.
The End of the Pandemic?
It seems that the worst of the Covid-19 pandemic is over.
Dr. Anthony Fauci believes that “we could start having some control over the pandemic come spring.” Moderna’s (NASDAQ:MRNA) CEO predicts that the pandemic will be over in a year.
McKinsey’s research indicates that “once a country has weathered a wave of Delta-driven cases, it may be able to resume the transition toward normalcy.” All of that is good news for the world. In all probability, we are moving from a pandemic to an endemic virus.
But the transition makes Zoom Video’s outlook more uncertain. It’s therefore not surprising that ZM stock has been trending lower even as the company continues to report healthy financial results. The stock seems to be reflecting the end of the pandemic.
Scouting for Acquisitions
An important point to mention is that Zoom’s revenue probably won’t collapse in a post-pandemic world. The Street is worried about its earnings growth following the pandemic, not its top line or cash flows.
I believe that Zoom is likely to aggressively pursue acquisitions to boost its earnings. As of the end of its Q2, Zoom reported cash and equivalents of $5.1 billion.
Furthermore, the company delivered operating cash flow of $468 million for the quarter. Zoom is therefore on-track for annual cash flows of $2.0 billion.
Recently, Zoom announced the termination of its agreement to merge with with Five9 (NASDAQ:FIVN). That is a near-term setback for the company.
Having said that, Zoom has ample funds to continue pursuing acquisitions that will enable it to grow and diversify. Acquisitions can help improve investors’ sentiment towards ZM stock.
I believe that geographical diversification would likely boost Zoom’s support growth. In Q2, 66.7% of its revenue came from the Americas. However, its revenue growth was higher in the rest of the world than in the Americas. It remains to be seen if Zoom can increase its market share in emerging nations.
The Bottom Line on ZM Stock
Zoom Video is already a cash-flow machine. The company’s cash-flow outlook for the coming years is certain. Ultimately, though, free cash flows form the basis of companies’ valuations.
If Zoom is unable to accelerate or sustain its growth, ZM stock is likely to remain depressed. Once its growth trajectory in a post-pandemic world becomes more certain, it’s likely to rally again.
For now, I would stay away from ZM stock as the end of the pandemic approaches.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.