Zoom Offers The Best Of Both Worlds: Growth Plus A HedgeSubmitted by Silverlight Asset Management, LLC on June 18th, 2020
Zoom Video Communications (ZM) is one of the hottest stocks of 2020.
Most conventional ‘value’ investors have missed it, of course. They usually pass on high-growth names, preferring stocks with cheaper valuations.
Don’t make this mistake.
In a portfolio, the forest is more important than the trees. Using that prism, Zoom may offer investors the best of both worlds: hyper growth plus a portfolio hedge.
Zoom’s Growth Story
Zoom is a video communications platform that connects people through video, chat, voice and content sharing. It is helping lead the charge to a new virtual work paradigm.
You know you’re doing something right as a company when analysts say things like this:
"One of the best quarters in software history."
- Rishi Jaluria, D.A. Davidson
"A performance unlike any we’ve seen in 20+ years of tech coverage."
- Richard Valera, Needham
"Easily the most stunningly positive quarter that we can recall in 18 years on the sell side."
- Tom Roderick, Stifel
In the quarter ended April 30, Zoom didn’t just beat estimates—it blew them away.
- Revenue was $328.2 million compared to expectations for $202.5 million.
- Management guided for revenue in the current quarter of $495 million to $500 million, with non-GAAP profit of 44 to 46 cents per share. Before the call, analysts expected $223.3 million and 11 cents.
Zoom has grown its daily meeting participants from 10 million in December to over 300 million.
Going forward, the company is focused on building better security protocols, cross-selling its new Zoom Phone product, and gaining more traction overseas—where only 20% of sales are derived. Adding all that up, it’s clear why some analysts project a five-year revenue CAGR north of 50%.
This isn’t just a company growing fast, either. Zoom also has an exceptionally profitable financial model, evidenced by a Rule of 40 score (growth rate + profit margin) near 100%.
Why Zoom Is An Attractive Hedge
As it was becoming clear Covid-19 would severely disrupt the economy, risk assets plummeted. Volatility surged to the second highest level ever in March.
The National Bureau of Economic Research (NBER) recently announced the U.S. economic expansion officially ended in February. The cycle wasn’t particularly robust in terms of growth, but managed to last 128 months—a new record.
The recession has brought swift declines in employment and production, unlike anything we’ve previously seen in the modern era. There are signs this may be one of the shortest recessions ever, but the jury is still out.
“It does seem like there has been an improvement in the economy since mid-April,” said James Stock, a Harvard economist and NBER committee member. In a Bloomberg interview, Stock added that he worries a “second wave” of infections could hinder the recovery.
A sluggish reopening of the economy is the chief overhang for risk assets near-term. We can partially hedge that risk, though, by investing in Zoom.
Zoom is part of a select group of “Stay at Home” stocks. The economic shutdown boosts short-term demand for its service. This explains why Zoom tends to hang in there on the market’s darkest days.
The purpose of a ‘hedge’ is to provide a positive return source when most positions in a portfolio do poorly. If we look at the five largest daily declines for the S&P 500 year-to-date, we see Zoom averaged a positive return.
Under the surface of the market, ‘style volatility’ has also picked up.
Value and Momentum factors are seeing the most dramatic swings in relative performance.
Different styles lead at different times. But if you happen to be wedded to a style that goes out of favor for a long time, it can be painful.
Credit Suisse HOLT helps investors monitor performance trends across different categories of stocks, using a proprietary, factor-based approach. In a recent report, they highlighted the excess returns from ‘Hyper Growth’ stocks (high growth, low quality) since 2017.
Dates of study: 12/31/2016 - 5/31/2020. Total Returns – Equally Weighted in $USD. Source: HOLT
‘Cyclical value’ investors may think hyper growth stocks are a “bubble” to avoid. However, considering their own style’s relative performance trend, perhaps they shouldn’t be too dismissive.
You can call yourself a value investor and still own a few stocks like Zoom. Doing so makes for a smoother ride. Therefore, unless restricted by certain mandates, most investors should intentionally diversify style exposures.
For example, portfolios I manage for clients have a natural tilt away from Hyper Growth, which is a byproduct of our investment process. The “core” of our portfolio is comprised of high quality firms we think offer attractive relative value.
Hyper growth stocks never screen well on our standard criteria. Always too expensive. For a long time, I never owned them. Then I woke up.
We own Zoom as a ‘counter-strategy’ position—meaning mainly for diversification purposes. If hyper growth remains the “place to be” in the market, we’re counting on Zoom to capture some of that upside.
Why Zoom over other hyper growth stocks?
First, we were an early adopter of Zoom’s product and get the value proposition and scalability. As Peter Lynch says, “Buy what you know.”
Second, “zoom” is close to becoming a mainstream verb. Quite rare for a company. It signifies a powerful combination of brand and network effects. Other examples of platform companies that achieved this include Google and Facebook.
Third, the technical setup was attractive. Timing is especially critical when dealing with volatile stocks like Zoom.
In closing, remember flexibility is key with investing.
Stocks like Zoom are not inherently “risky” or “expensive.” Those are just subjective interpretations.
What really matters is the role a security plays in a portfolio, and whether that portfolio achieves your long-term goals.
Originally published by Forbes. Reprinted with permission.
This material is not intended to be relied upon as a forecast, research or investment advice. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by Silverlight Asset Management LLC to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by Silverlight Asset Management LLC, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.