Investors are far too excited about videoconferencing group Zoom Video Communications
The relative failure of Uber’s initial public offering (IPO) to meet investors’ expectations has led to speculation that the seemingly limitless investor appetite for tech shares may be finally cooling. Despite this, it’s not all doom and gloom for the tech sector, since some recent IPOs have performed better than anticipated.
One company that has thus far surpassed expectations is Zoom Video Communications (Nasdaq: ZM). After going public in April at $36 per share it has continued to soar to just under $80 a share, which gives the videoconferencing company a total market cap of $20bn.
It’s not difficult to understand why people are so enthusiastic about Zoom. The rapid growth of flexible, part-time and remote working means that demand for videoconferencing is set to expand by roughly 14% a year over the next few years. Zoom’s internet-based service has been praised for its simplicity, affordability and flexibility; it suits both large and small organisations. Zoom’s management claims the company’s service will not only win a large share of the market, but can also expand the market in areas such as distance-learning and medicine.
These are all compelling reasons to be bullish, while the fact that Zoom’s revenue has grown fivefold from $61m to $330m over the past two years also suggests the company has a huge amount of potential. Still, this doesn’t justify a price that values it at an eye-watering 400 times 2021 earnings. Of course many analysts argue that sales may be a better measure than profits for a fast-growing tech company. However, even if you use this measure Zoom still looks extremely overvalued, trading at more than 20 times 2021 revenue. By contrast, even Pinterest, another tech firm that looks overvalued, trades at only ten times 2020 revenue.
Expect a slowdown
What’s more, there’s no guarantee that Zoom will be able to keep growing sales at the expected rate. After all, many companies are trying to take advantage of the videoconferencing boom, including Microsoft, Google and Cisco, all of which have ample resources they could use to muscle into the market.
Zoom’s business model also relies on people upgrading from the basic service, which Zoom offers free, to premium versions, which require an annual or monthly subscription. However, if people don’t upgrade, and just stick with the free service, then Zoom could be in trouble.
Of course, even if a stock is as grotesquely overvalued as Zoom, there is always the risk that it could become even more overvalued before it falls back (as investors who shorted Zoom just after it was floated have found out the hard way).
As a result, I’m advising you to hold off shorting the share until it falls back at least 15% to $68. When it does fall below $68, I’d advise you to short it at £58 per $1, covering your position if it rises above $85. This gives you a maximum downside of £986.
Trading techniques… playing privatisations
As we’ve previously pointed out, IPOs tend to be a good deal for those who can subscribe at the initial price and then immediately sell. Those who buy after the first day of trading lag the market. An exception to this rule is stock in previously state-owned firms.
During the 1980s the British government floated many state-run firms on the stockmarket. Not only did they raise a large amount of revenue, but they also captured the imagination of first-time investors, helped by clever publicity campaigns, such as the “Tell Sid” advert promoting the 1986 listing of British Gas. As a result, governments around the world rushed to copy Britain (an estimated $700bn in former state enterprises were listed on global stockmarkets between 1986 and 1999, followed by a further $500bn between 2000 and 2012).
A 2000 study led by the University of Miami looked at the returns for 158 privatisations covering 35 countries. It found that shares in newly privatised firms generated impressive short-term stockmarket returns and outperformed their domestic stockmarkets over one, three and five years.
Of course, not all privatised companies prove to be wise investments, as shareholders in Royal Mail (currently below its original price) know to their cost. One red flag is the government insisting on retaining a substantial number of shares. A 2008 study found that Chinese firms with a large degree of residual state ownership have had lower returns than those where private shareholders controlled most or all the shares.
How my tips have fared
This week’s volatile market backdrop has proved bad news for my recommended long positions, with all eight declining in value.
Cineworld has fallen from 321p to 299p, triggering the stop-loss at 300p (which means that you would have made a small profit). John Laing Group slipped from 387p to 382p, JD Sports now costs 611p (from 617p), Hays is 146p (153p), Safestore is 643p (646p) and Somero is 355p (365p).
While most of these declines are relatively minor, Bellway and Superdry performed poorly. Bellway declined from 3,157p to 2,998p and Superdry from 534p to 455p.
While the share price of Pinterest has declined, it has not yet fallen through the $25 barrier that would show that it had gained enough negative momentum to be worth shorting, so I have just three recommended short positions: Weis, Rightmove and Tesla.
Rightmove actually increased, albeit by only 1p to 549p. Weis declined from $41.90 to $40.22 and Tesla fell from $242 to $231. Having suggested shorting Tesla on two previous occasions (issues 854 and 892), I’m enjoying turning a profit on the car company as it seeks to raise additional cash to repay debt.
If you had followed our tips you would be making profits of £1,576 on the seven remaining open positions, and £158 on the three short tips.
This is more than the losses of £853 on the closed positions. I’m not going to close any more positions now, though I will raise the stop-loss on John Laing Group and JD Sports to 340p and 400p respectively. I’m also cutting the stop-losses on Weis and Rightmove to $44 and 700p respectively. Over the next few weeks I hope to increase the number of shorts to make the recommended portfolio more balanced.