Zoom: Ignore The Pandemic; Focus On The Facts

Summary

• Zoom is more than just a pandemic-specific stock; the company has leapfrogged the traditional marketing phase to become a household name.
• Earnings sentiment predict excess returns.
• The post-earnings gap is hard to predict but shows more potential in the long trade than the short one.
• This idea was discussed in more depth with members of my private investing community, Exposing Earnings. Get started today »

Prior to Zoom’s (NASDAQ:ZM) earnings, when the stock was trading at $370, I recommended my subscribers either sell the Mar19 $400 puts into earnings or – alternatively – buy the Mar5 $450 calls. The former resulted in a profit of $8000 per contract, and the latter resulted in a profit of roughly $650 per contract, assuming you sell at the open today (Mar2).

My thesis was mostly earnings-based and based on statistical data – for the sake of short-term trading. But now that we have a position, it is important to determine a longer-term thesis so as to determine whether to hold or sell. Today, I want to give my general thesis on Zoom, run a lexical analysis on the most recent Zoom earnings call, and backtest the up gap that will appear today at market open.

Let’s start with the general thesis.

Zoom as a Company

Zoom became a household name during the pandemic. Many still do not understand why Zoom, of all programs, became the go-to platform for video conferencing. People who were aware of Zoom prior to the pandemic (and there are many) know exactly why the pandemic helped push Zoom into the mainstream: It is virtually the only video conferencing platform that can handle large groups. (Competitors do exist but are not widely employed. Cisco’s (CSCO) WebEx, for example, can act as a Zoom surrogate but is notoriously difficult to set up and utilize, which is especially problematic considering many of those who suddenly found the need for large-group video conferencing are not exactly tech-savvy.)

Prior to the pandemic, few people needed video conferencing for large groups (e.g., public school classes, court cases). With large meetings taking place in public, Zoom was unnecessary. And for most video conferencing situations – those either one-to-one or in small groups – simple platforms, such as Skype, did their jobs. The gravitation toward Zoom was due primarily to the need for a video conferencing platform that could handle large groups in light of the lack of any reliable alternatives; today, Zoom remains the only reliable platform for this purpose.

In other words, Zoom was already a unique company prior to the pandemic, albeit niche at the time. The pandemic simply drove demand for the platform. While the company could not have predicted a worldwide pandemic to create demand for its product, it did create a platform that was in its own league – a platform with a clear unique selling proposition: “We can handle video conferencing at volumes our competitors cannot.”

That is, Zoom knows its business and has a clear focus. It was lucky to be positioned as it was during the pandemic, and many of the bear cases stem from this “luck” standpoint: Once the pandemic is over, Zoom usage will decline. However, I disagree with such a thesis.

For one, Zoom has already become a household name and is known as the go-to platform for video conferencing with large groups. Prior to the pandemic, most wanting to run a large online meeting would be forced to run through the search engine game of finding the correct software and then convincing everyone potentially joining the meeting to install said software. After the pandemic, the go-to source for a large online meeting is clear – and many potential attendees likely already have Zoom installed on their computers; this allows the company to skip what would otherwise be an impossible marketing endeavor.

So even assuming the amount of online meetings drops to their pre-pandemic levels after the world gains herd immunity, Zoom stock should be worth more than its pre-pandemic levels due to the lower barrier of entry of use – i.e., it will now be the go-to solution for large group meetings without any need for marketing or brand recognition campaigns. This small company has had its marketing campaign completed by a combination of the pandemic and being the best in its category, essentially bypassing the need to market itself against bigger, richer, companies that are household names but without household-name video conferencing software.

While most know of “Zoom,” few know of “WebEx” or “Meet,” Zoom competitors from Cisco and Google (GOOG) (GOOGL), respectively. In the long term, the pandemic should be seen more as a (bullish) discount to marketing rather than a (bearish) impetus for a temporary fad.

And that summarizes my main thesis on Zoom at this time. Simply put, the pandemic did not change the company: Zoom was already successful in what it did prior to the pandemic. The pandemic merely allowed the company to immediately become a household name without the costs that would normally be required in obtaining that status.

Zoom now is the same Zoom in 2019 but with much more brand recognition and with expedited user feedback due to a surge in use in 2020. The run-up in the stock might have been fueled by fears that we will never go back to in-person group meetings, but that’s merely an overpricing, saying nothing substantial about the underlying company. Zoom is down 33% from its high, and so it is hard to call the stock a “meme” at this point, especially considering that it has trended roughly sideways for the past few months.

A 300% increase since the beginning of the pandemic seems fair even if you believe Covid-19 will disappear in the coming year: That 3x increase in the stock price can be attributed to the company immediately becoming both a household name and the market leader for group video conferencing. Many companies spend decades and much of their cashflow attempting to gain the same status, often failing, because doing so can increase company value even more than three-fold, especially in the tech market, which tends to be trend-based.

In short, Zoom is the true market leader and perceived as the only choice for many consumers in the group video chat market. The pandemic allowed the company to waive the efforts and costs usually required for gaining such a status, and even the end of the pandemic will not delete “Zoom” from the zeitgeist. In this light, and without any true competitors, Zoom stands out as an uncommon tech company that's holding a market lead in a niched space, not one fighting for space in a sector that is becoming a commodity due to increased competition (e.g., Internet service providers or streaming services).

With the leapfrogging over marketing costs, the lack of competitors, and significant earnings growth in the last few months, Zoom stands out as a strong investment in tech.

Earnings Sentiment

As Zoom has just released its FQ4, 2021 earnings report, I wanted to take a look at any significant changes in management sentiment. To do this, I ran a financial lexical analysis on the company’s earnings calls. We are looking for changes in sentiment, as measured by the ratio of positive-to-negative forward-looking statements within the earnings call.

Here is what I found: The sentiment last quarter was roughly average, which can help explain the consolidation we have seen this quarter. One year ago, the sentiment was more positive; likewise, we saw a rise in the stock price. This quarter’s sentiment, however, was extremely optimistic, coming in at 60% higher than average and 27% higher than that of FQ4 of last year.

Sentiment can help predict future excess returns for stocks. We see that sentiment worked pretty well for Zoom over the past year, as well:

(Source: Stockcharts)

Putting it all together, we should expect Zoom to continue upward in the coming quarter, showing excess returns. If you use sentiment alone, in a vacuum, then the rise should be stronger than that of March to June. However, we should always consider other factors – and the post-March movement was clearly driven by the general market upswing and long-term lockdown fears. I think sentiment here should be discounted a bit for these reasons. I expect an upward movement somewhere between that of last year and last quarter.

The Gap

On a final note, many companies “jump” on good earnings, creating a gap. The up-gap on ZM looks like a breakaway gap, but I wanted to backtest it before making such a declaration. Unfortunately, as ZM is a relatively new stock, we lack abundant data.

Still, with the data we have, we find that going long on this gap is actually profitable:

(Source: Damon Verial; data from Tiingo)

But the profits from trading this gap on the long side come from the imbalance between the upward movements and downward movements. The backtest actually shows the gap to be just as likely to be an area gap as a breakaway gap. In other words, while the price movement tends to be a random post-gap, the upward movements have been more violent than the pullbacks, meaning going long on ZM after a gap is not a losing strategy.

In short, if you are long ZM after the gap, statistically you stand more to gain from holding rather than taking profits in an attempt to avoid losses.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ZM over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.