Best Stocks of the Year: Zoom Video Is Number 2

The videoconferencing firm's growth has been greatly accelerated by the pandemic, but it likely won't be the end of it.
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TheStreet is just a few days away from revealing its consensus pick for the stock of the year in 2020. After having revealed our choices for No. 25 through, today, No. 2., please check back on Monday morning to see who our writers and columnists chose for the No. 1 Stock of the Year based on everything from stock performance to quarterly results to execution, in a year that posed challenges like no other.

Picks 25-21 20-16 15-11 10-6 No. 5 No. 4 No. 3

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Great businesses offer easy-to-use, reliable products that customers enjoy. Before getting into more specific details, this is the foundation of Zoom Video Communication  (ZM) - Get Report, one of the best investments of 2020.

The San Jose, Calif.-based company clearly benefitted from the work-from-home movement. Its video platform won legions of new users during the pandemic.

However, Zoom’s business success predates COVID-19, and it is likely to continue after the pandemic is just a bad memory.

Zoom began when a former Cisco Systems  (CSCO) - Get Report executive became frustrated with the state of videoconferencing. Eric Yuan came to the network giant in 2007 in the acquisition of WebEx, a videoconference software suite. Yuan was embarrassed by customer complaints about software that was hard to set up and had laggy, poor image quality. When he ultimately left Cisco in 2011 to start Zoom, almost 40 engineers followed.

After raising $3 million in startup capital the team began building from scratch a cloud based, video-first platform. They worked tirelessly to ensure good video quality and low latency even when with low bandwidth conditions. From the beginning, Zoom’s simplified user interface and better value proposition was a winner with corporate accounts.

The first iteration rolled out in Jan. 2013. By May that year, Yuan claimed Zoom crossed 1 million users. Only a year later the fledgling video platform had grown tenfold on the strength of a $9.99 monthly subscription that included HD video conferencing, mobility and web meetings.

When COVID-19 reached American shores in Jan. 2020, Zoom was profitable and well regarded in the tech community. The videoconferencing platform was also consistently winning market share from Cisco, Microsoft  (MSFT) - Get Report, Alphabet  (GOOGL) - Get Report and GotoMeeting.

The pandemic was a call to action. Managers took their foundational principles of simplicity, stability and customer happiness and began to build a new, much larger business.

This “land and expand” strategy involved grabbing enterprise market share by getting Zoom into the hands of as many users as possible, then cross-selling add-ons. This plan was well underway in March when something remarkable occurred.

As major cities locked down, Zoom crossed over from enterprises into the mainstream. It made sense. The software was so clean and simple that almost anyone could pick it up and broadcast to their family, friends and coworkers within minutes. And in most cases, non-corporate use was free. "Zooming" became a verb, as "Google" had before it. It entered pop culture when some of the cast of the hit play “Alexander Hamilton” changed the words to one of their songs to “The Zoom Where It Happened”.

The mobile applications zoomed to the top of iPhone and Android app store download lists. Yuan noted in June that peak daily users reached 300 million. The number of Zoom meeting minutes soared to an annualized 2 trillion run rate.

The platform was a monster, which created its own problems.

Thankfully, Yuan began bolstering security in April. He brought in Alex Stamos, the former chief security officer at Facebook  (FB) - Get Report, as an advisor. Keybase, a security specialist, was acquired to beef up cybersecurity engineering talent. By the end of the month the fifth iteration of the Zoom platform featured 256-bit encryption.

Throughout the platform mayhem the core enterprise business was booming. Second-quarter new licenses increased by 175,000. Sales for the quarter grew to $328 million, up 169% year-over-year. Free cash flow jumped a staggering 1,541% to $251 million.

Since June, Zoom managers have continued to build. They announced new partnerships with hardware vendors, a Zoom for Home project to capitalize on all of the non-corporate accounts, and even more progress with enterprises.

Third-quarter profits reported in November reached $192 million on sales of $777 million, an operating margin of 24.7%. Revenues ballooned 367% versus a year ago. Yuan says the business should generate approximately $2.6 billion in sales during the current fiscal year. Income should come in at $868 million, or $2.68 per share based on 300 million shares outstanding.

The knock against Zoom now is simply investor expectations.

Shares have risen 487% in 2020 alone, pushing the market capitalization to $113.6 billion. At roughly 60x sales and 125x forward earnings, it’s hard to make the case the business is undiscovered.

The reason for investors to be optimistic is Zoom managers remain relentlessly focused on building something better. The foundation of that plan is reliable products that are easy to use and customers love.

It’s a solid footing to create more shareholder wealth. 

Veteran tech columnist Jon Markman publishes Strategic Advantage, a popular guide to investing in the great digital transformation of business and society. Click here for a free two-week trial.

How TheStreet Chose the Best Stocks of the Year

TheStreet polled a group of 16 writers and editors at TheStreet, RealMoney, Action Alerts Plus, Stocks Under $10 and Trifecta Stocks and asked them to nominate candidates, and then narrowed that list down to the top 25 stocks. We then asked each of those writers and editors to rank the top 25 from top to bottom, assigning 25 points for a No. 1 ranking, 24 points for a No. 2 ranking, etc. We then totaled the points for each stock to arrive at our final rankings.

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