When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Zoom Video Communications, Inc. (NASDAQ:ZM) as a stock to potentially avoid with its 24.4x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Recent times have been pleasing for Zoom Video Communications as its earnings have risen in spite of the market's earnings going into reverse. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
How Is Zoom Video Communications' Growth Trending?
There's an inherent assumption that a company should outperform the market for P/E ratios like Zoom Video Communications' to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 496% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 18% drop in EPS in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 3.3% per year over the next three years. With the market predicted to deliver 10% growth per annum, that's a disappointing outcome.
In light of this, it's alarming that Zoom Video Communications' P/E sits above the majority of other companies. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.
The Key Takeaway
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We've established that Zoom Video Communications currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Zoom Video Communications (1 is concerning) you should be aware of.
Of course, you might also be able to find a better stock than Zoom Video Communications. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
