On Thursday (April 2), legendary short-seller Jim Chanos warned that investors should be wary of "coronavirus stocks" that are temporarily surging due to a large volume of "stay at home" users engaging their services.
These companies have experienced a swoon of demand thanks to the changing consumer and business behaviors fueled by the lockdown across the United States.
Perhaps there is no bigger example than Zoom Video Communications Inc. (NASDAQ: ZM).
Zoom is a popular video conferencing platform that competes with Google Hangouts by Alphabet Inc. (NASDAQ: GOOGL), Slack Technologies Inc. (NYSE: WORK), and Teams by Microsoft Corp. (NASDAQ: MSFT).
Because millions of employees are stuck at home, the company has seen a surge in usage. Employees have relied on video conferencing to communicate in meetings. The firm reported 200 million daily users in March, a figure that dwarfed its previous record of 10 million in the past.
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Naturally, the explosion in use has many people wondering if they should buy Zoom stock now.
The answer has absolutely nothing to do with Jim Chanos, its explosion in demand, or the recent headlines about Zoom bombing and hacking across the country.
The Only Number That Matters for Zoom Stock
"Twenty million daily active users" is an eyepopping figure.
So too are the rising number of companies that are banning usage due to security concerns - a list that includes SpaceX and NASA.
But there's another number that you should know if you plan to "buy and hold" Zoom stock because you believe teleconferencing will be a trend that sticks after the coronavirus crisis.
It's 61.39.
That's the company's price-to-sales ratio.
That means the stock is trading at 61.39 times its most recent revenue figures over the last 12 months.
A lot of people ignore price to sale because they prefer to use price/earnings as a comparison metric.
But price to sales can tell you a lot about a company's stock and the probability that it's going to fall in the future.
Combine price-to-sales with short interest, and you get a predictive measure. (Short interest is the total percentage of shares floating on the market that have been borrowed but not yet covered by traders.)
Short interest is important. The higher the short interest, the more negative the market is about the direction of a stock in the future.
If you purchase a stock trading above 20 times its 12-month trailing revenue [TTM] when short interest is rising, you're taking a risk.
Since 2000, stocks trading at 20x revenue with a special recipe of increasing short interest have lost - on average - 20% per year.
But Zoom isn't trading at 20x revenue.
It's trading at 61.79 times revenue.
That can be dangerous if you don't know what you're buying into.
Zoom Stock Looks Expensive, but You Can Still Profit
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Let's take a look at some hot IT and communications stocks like Zoom that have imploded in just the last year alone using rising short interest and high price-to-sales ratios.
In September 2019, Roku traded at 21.4 times sales with rising short interest with a high of $176.55 per share. By Jan. 31, before this pandemic even started, shares pulled back to $120.95 per share. Today, they're trading at $84.
In August 2019, Paysign traded at 27.8 times trailing revenue. This was one of the hottest stocks in the world over three years, but shorts targeted that high price-to-sales. Shares fell from $18.67 in August to under $9 by late January.
Today, it trades at $4.
For anyone looking to go back further, pay attention to FireEye, which traded at 55 times revenue in March 2014 at more than $80 per share.
Months later, it fell to under $30. And it hasn't been above $20 in four years.
There are many other examples. But history has shown that overhyped technologies can hurt investors and leave some people holding the bag.
Not only does it face current concerns about its security, but there has already been a wave of new competitors like Houseparty to emerge. Expect more competition and more scrutiny.
How to Trade Zoom Stock Now
Buying and holding Zoom for the long term right now is risky because of how expensive it is. If you do want to invest, we recommend dollar-cost averaging.
However, there are ways to make money using options. For example, you could purchase the stock on a down day, wait for a bounce back, and then sell covered calls to generate income on your investment.
In addition, you might wish to play the trend of stocks with high price-to-revenue ratios with long-dated puts that suggest prices could pull back under $80 at a more reasonable valuation.
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