Following its IPO debut on April 18, the Zoom stock price skyrocketed 72.2% in just one day from its opening of $36 a share. But this massive price increase should be a warning sign for retail investors interested in buying Zoom stock.
While Zoom Video Communications Inc. (NASDAQ: ZM) has analysts everywhere hyping it up, it's a good idea to wait six months to a year before buying Zoom stock.
Prior to Zoom's public offering, the company's goal during the IPO period was to raise $100 million with roughly 9.9 million shares. But the firm is now slightly overvalued after raising $145 million from venture capitalists before its IPO.
Sure, there are plenty of great things about Zoom. But its pre-IPO valuation had shares valued at $28 to $32. This means its IPO price was already 12.5% to 28.57% higher than it was initially valued by private investors. And right now it's already up 80.6% from the price institutional investors paid.
If you've been following Money Morning, you already understand how risky early IPOs can be. The first six months are normally very volatile. This has certainly been the case for big tech "unicorns" like Lyft.
Since its IPO, Lyft shares have dropped a whopping 32.6% to $59.33 from the $88 retail investors had to pay per share.
But there is some pretty valid hype behind Zoom's stock. Unlike the completely disastrous Lyft IPO, Zoom is one of the rare "unicorns" making a profit. Its last gross profit came in at $269.5 million, with a net income of $7.6 million. Beyond that, CNBC says Zoom's total revenue skyrocketed 443.5% from 2017's $60.8 million to $330.5 million by year-end 2018.
While this massive increase in revenue makes Zoom a very tempting investment, it's better to let this IPO breathe a little before you invest in Zoom stock.
Here's exactly why, even for a company as profitable as Zoom...
Zoom's Path to Profitability
Zoom Video Communications was founded by Eric Yuan, the former vice president at Cisco Systems Inc. (NASDAQ: CSCO) back in 2011. He wanted to make video conferencing as easy and intuitive as possible, but he didn't think it could be done at Cisco. So, he pulled 40 engineers with him and started Zoom. Eight years later, the company is now valued at around $17.7 billion.
Zoom went live in 2013. Within four months, it gained 1 million users. Throughout the year, the company's popularity continued to soar rapidly, and it even partnered with Redbooth on B2B collaboration software.
Shortly after, Zoom started its own program, "Works with Zoom," to establish partnerships with software and hardware vendors. These companies include names like Vaddio and InFocus. However, Zoom also works with big companies like Yamaha Motor Co. Ltd. (OTCMKTS: YAMHF).
Within a year of its release, Zoom had accumulated 10 million users. The year after, 65,000 organizations and 40 million people were using Zoom.
Over the next several years, Zoom partnered with an incredible number of companies. It integrated its software with online interviewing platforms, toll-free telephone networks, sales software, Google, and Microsoft products and even offered screen-sharing on iOS.
With each integration, Zoom's products and popularity skyrocketed - even receiving $30 million in Series C funding.
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Back in 2017, the company was valued at $1 billion and had officially become a startup "unicorn." This earned them another $100 million in D Series funding from Sequoia Capital (NASDAQ: SEQUX), a venture capital firm with holdings in Apple Inc. (NASDAQ: AAPL) and Alphabet Inc. (NASDAQ: GOOGL).
Towards the end of 2017, Zoom was hosting 20 billion meeting minutes per year. Its revenue had jumped 150% and its customer base grew 100% - resulting in the company earning the 18th spot in Forbes' Cloud 100 list. The firm also integrated its software with Augmented Reality, Slack, Facebook's Workplace, and a speech-to-text AI converter.
Last year the company was valued at $8 billion, and CEO Eric Yuan was named Glassdoor's no. 1 CEO.
Zoom's pre-IPO value was estimated to be $8 to $9 billion - but it has now surpassed Lyft's $17.1 billion with a valuation of $17.7 billion in just one week.
While Zoom has had an incredible run so far, great corporate culture, and a well-respected CEO, Zoom stock is very risky for retail investors.
We'll show you exactly why, plus give you a huge tenfold opportunity for retail investors looking to profit from the technology industry...
Investing in Zoom Is Risky for Retail Investors
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Zoom's business depends entirely on the company's ability to gain and maintain a growing user base. But because the service is subscription-based, there's no guarantee that customers will renew their subscriptions - or even upgrade to higher-priced plans or additional products.
So Zoom has to continuously gain new customers at a rate faster than the company loses subscriptions. This means if there's any competition that offers more for less, then Zoom is vulnerable and likely to see a decline in subscriptions.
Beyond that, Zoom offers a free version of its meeting plan for customers to use. And because of this, customers may never upgrade to the "premium" versions. Even if Zoom maintains a large user base, if most of them are using the free version of the software, the company isn't making money.
As for that competition we just mentioned, Zoom is also operating in a pretty saturated market against other big names...
Right now, Zoom is competing with legacy web-based meeting providers like Skype for Business and Webex. However, it's also up against companies that have invested in video communication software like Facebook, Amazon Inc. (NASDAQ: AMZN), and Google.
So, as the company expands its products and cloud services, the more it will be in direct competition with major tech companies that have much longer operational history with similar services like Microsoft Corp. (NASDAQ: MSFT).
That makes Zoom's prospects after their IPO even shakier...
The Trouble with Early IPOs
CNBC says over 60% of some 7,000 IPOs between 1975 and 2011 had negative returns for five years after they went public. And while institutional investors stand to profit off of IPOs, it's a very different story for retail investors.
As we've already seen with Lyft, retail investors who had waited a few weeks would have been able to purchase Lyft's stock at a significantly lower price than it debuted. Unfortunately, many investors approach IPOs with the "act now or miss out" mentality, but very rarely does it work out.
Retail investors should always take a step back when the newest IPO is garnering a ton of hype.
Just look at Snap Inc.'s (NYSE: SNAP) 2017 IPO. It was considered to be one of the biggest tech IPOs in years, but within the year, the company's shares dropped 40% from $17 to $4.82 - and it's now only back up to $11.
Beyond that, even Facebook took an entire year to reach its IPO price again after it had gone public in 2012. While Facebook is extremely successful now, those volatile first 12 months didn't make investors any money.
That's why it's typically better to wait a minimum of six months, and ideally 12 to 18 months, before diving into a company's stock after its IPO.
Prices constantly fluctuate while venture capitalists and insider investors sell their shares. After all, the IPO is their first chance to cash out. However, once companies go public, they also have to start figuring out how to effectively operate like publicly traded entities.
Whenever it comes to IPOs, underwriters drive excitement and hype in order to maximize their potential short-term gains from IPOs. These underwriters aren't concerned with building long-term value for retail investors. Rather, they're looking to line their own pockets off of others' hope.
As a retail investor, if you wait a year after an IPO, you'll get a better idea of how the company operates and how it may perform in the long term.
You should never invest in a company just because it's a big name hyped up by the media. Media hype tends to rely on emotion rather than what's important: the financials.
Money Morning cannot recommend investing in Zoom stock right now. Instead, wait six months to a year. Then, check the company's financials and decide from there. But for now, we have a huge opportunity for retail investors that could net double- or even triple-digit profits...
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About the Author
Daniel Smoot is a Baltimore-based editor who helps everyday investors with stock recommendations and analysis. He regularly writes about initial public offerings, technology, and more. He earned a Bachelor's degree from Towson University.