The onset of the novel coronavirus put enormous pressure on the U.S. stock market, but not all businesses were impacted equally. If you had to choose one company that thrived the most during the pandemic, a reasonable choice would be Zoom Video Communications (NASDAQ:ZM). At the same time, ZM stock holders easily outperformed the major market indexes.
Indeed, ZM stock could be considered the poster child of “coronavirus stocks” that posted huge gains throughout this challenging time. It makes sense since teleconferencing has replaced face-to-face interactions for many businesses and individuals this year.
Just about everything associated with ZM stock “zoomed” in 2020, it seems. The price skyrocketed even while many other businesses floundered. Moreover, the trading volume on the stock increased dramatically.
There’s no shortage of evidence to show that as a company, Zoom is doing quite well. Yet, informed investors must remember that price matters, and so does valuation. After you see one particular number, you might be persuaded to avoid ZM stock until some of the air is let out of the valuation balloon.
A Closer Look at ZM Stock
From the outset, traders weren’t given much time to ponder whether they wanted to buy ZM stock. Immediately after the April 18 initial public offering, the ZM share price took off like a rocket. In fact, it closed up 72% at the end of its first trading session.
At that time, ZM stock might have seemed overvalued as it was trading at roughly 50 times the company’s enterprise value. Still, prescient analysts and traders saw that there was more room to run. For example, D.A. Davidson analyst Rishi Jaluria predicted that Zoom “could become the de facto standard for videoconferencing.”
Plenty of people and businesses still use Skype, but Jaluria was essentially spot-on as Zoom quickly became a household name. It didn’t take very long before Zoom’s growth was reflected in the ZM share price.
The company priced ZM stock at $36 at the IPO. By the end of August, the shares were trading at around the $306 level. That by itself should raise a red flag for value-focused investors. Yet, there’s another detail about ZM which cautious traders might find off-putting.
Valuation Still Matters
In a time when expensive stocks only seem to get more expensive, it might feel like traditional valuation metrics don’t matter anymore. Still, even the most overzealous momentum traders should bristle at the number I’m about to report here.
If you can believe it, ZM stock has a trailing 12-month price-to-earnings ratio of 1,749.71. This figure makes high flyers like Amazon (NASDAQ:AMZN) and Tesla (NASDAQ:TSLA) look like bargains in comparison.
Take a moment to consider what this number means. The price of ZM stock is roughly 1,750 times greater than what the company has, during the measured time frame, earned per share.
Questionable Math
Looking at it from a different angle, the market has priced in Zoom’s impressive growth. Most likely, it has also assumed a continuation of that growth well into the future. When it comes to ZM stock, then, the market has gone from efficient to over-efficient and is therefore inefficient.
Plus, Zoom might have been a bit overzealous in reporting its user growth. As InvestorPlace contributor Chris Lau reports, the company may have found a clever way to magnify the data:
On the company’s Q1 earnings conference call, Zoom CEO Eric Yuan reported that individuals who join multiple meetings in a day are counted as multiple users. For example, he noted that an individual who joins five meetings in one day on Zoom would be counted as five separate users.
In any case, Zoom’s future growth in terms of actual users (as opposed to what the company reports using its fuzzy math) will need to be absolutely exponential in order to justify ZM stock’s incredibly high valuation.
The Bottom Line
There’s really nothing stopping ZM stock from increasing in price for the remainder of the year. Expensive stocks can keep going up for a long time.
If valuation means anything anymore, it’s time for investors to tap the brakes and reconsider their enthusiasm for ZM stock.
On the date of publication, David Moadel did not have (either directly or indirectly) any positions in the securities mentioned in this article.