Global lockdowns amidst the COVID-19 health crisis led to wide usage of online communication platforms for remote work and socialization. Today’s FA Alpha Daily will take a closer look at Zoom Video Communications (ZM), one of the largest video communication providers, to assess why its strong profitability, high growth potential, and low valuations make it an interesting company for FA Alpha.
Online meetings have become a part of our life for a long time.
The need for video communications in politics, business, or just for leisure has always been a dream of science fiction writers of the 20th century.
This dream became a reality when Nippon Telegraph and Telephone (9432:JPN) deployed a video conferencing network between Tokyo and Osaka for corporate use in 1976.
Since then, a lot has changed to make the technology accessible to all for cheap. Now, we pull our smartphones out of our pockets, or open up our laptop to connect over video from anywhere over the world in a moment.
The market quickly was clued into the importance of video communication once more, especially in the early days of the pandemic. From business meetings to personal use, video communication became vital to the new world of working from home.
And there is no company that benefited from this situation more than Zoom Video Communications (ZM).
Most of the webinars, presentations and business meetings are done via Zoom. Even if your company or friends use a different service for video calls, you have definitely heard of it.
A company so mainstream selling a product so widely used should have been printing money through the pandemic.
However, as-reported metrics suggest that the company is not as profitable as one would assume.
As-reported metrics show that Zoom’s return on assets (“ROA”) in 2021 and 2022 were 13% and 11% respectively.
Considering the At-Home Revolution tailwinds and its growth potential, these numbers would imply Zoom failed to capitalize on the huge boost in adoption during the pandemic.
However, these numbers are not accurate. The as-reported metrics distort the company’s true profitability and make it seem much worse than it is.
The Uniform metrics show us the true profitability of Zoom. The company has actually been producing massive returns with ROA rising from 36% in 2019 to 198% in 2021.
Even last year, as people returned to some semblance of normal, ROA was at 165%, and the company was still investing massively. Asset growth was 85% in 2021 as Zoom has grown to meet customer expectations.
And yet even with the company’s high profitability and healthy growth, the market isn’t recognizing the company’s potential. For a company with returns and growth magnitudes above corporate averages, a 30x P/E is below a reasonable price.
High growth potential, three-digit ROA, and low valuations make Zoom an impressive name for the FA Alpha 50.
Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.
Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”
Investors who neglect the very real issues with as-reported accounting can find themselves caught up investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.
The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.
The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies, but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.
That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.
This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.
See for yourself below.
To see the other 49 names on the list, click here.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research