Better Buy: Zoom Video Communications vs. Microsoft

Can David beat Goliath in the long game for US tech shares?

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Zoom Video Communications Inc (NASDAQ: ZM) was one of the hottest growth stocks of the year, rallying over 270% as the COVID-19 crisis brought millions of new users to its video collaboration platform. That growth attracted the attention of larger tech companies like Microsoft Corporation (NASDAQ: MSFT), which aggressively promoted Teams as an alternative to Zoom.

Zoom easily outpaced Microsoft's 30% gain this year, and it likely remains a more appealing stock for growth-oriented investors. But is Zoom actually a better long-term investment than Microsoft?

David vs. Goliath

Zoom has a market cap of more than $70 billion, but it's dwarfed by Microsoft's valuation of over $1.5 trillion. Microsoft also generated 230 times as much revenue and over 2,000 times as much generally accepted accounting principles (GAAP) profit as Zoom last year.

Zoom is also trading at much higher valuations than Microsoft. Zoom trades at 200 times forward earnings, while Microsoft has a more grounded forward price-to-earnings (P/E) ratio of 31. Zoom trades at 40 times this year's sales, compared to Microsoft's cooler forward price-to-sales (P/S) ratio of 10.

The bears will argue that Zoom is overvalued, while the bulls will claim its valuations are justified by its growth rates.

How fast is Zoom growing?

Zoom's revenue surged 88% to $622.7 million in fiscal 2020, which ended this January, as its adjusted net income surged 514% to $101.3 million.

In the first quarter, which bore the full impact of the COVID-19 shutdowns, Zoom's revenue rose 169% annually to $328.2 million, and its adjusted net income soared 555% to $58.3 million. Its number of customers contributing over $100,000 in revenues over the past 12 months also grew 90% annually.

For the full year, Zoom expects its revenue to rise 185% to 189%, and for its adjusted earnings-per-share (EPS) to grow 246% to 269%. But after that growth spurt, analysts expect Zoom's revenue and earnings to rise 25% and 19%, respectively, in fiscal 2022.

Investors should take those forecasts with a grain of salt, but they suggest Zoom's COVID-19 boost could fade as it faces stiff competition from rivals like Cisco's Webex, Facebook's Messenger Rooms, Alphabet's Google Meet, and Microsoft Teams.

Zoom surpassed 300 million daily active-meeting participants in April but admitted that was a "peak" during last quarter's conference call. Microsoft claimed Teams hit 75 million daily active users in April but hasn't updated that figure since.

How fast is Microsoft growing?

Microsoft's revenue rose 13% to $143 billion in fiscal 2020, which ended in June, as its adjusted EPS grew 14%. The COVID-19 crisis mainly curbed the growth of Microsoft's Productivity and Business Processes unit, which sells productivity software like Office and Dynamics to enterprise customers.

Microsoft CEO Satya Nadella.

Image source: Microsoft.

However, Microsoft's Intelligent Cloud unit, which houses its cloud platform Azure and server products, benefited from the higher usage of cloud services throughout the crisis. Its More Personal Computing unit -- which sells its Windows licenses, Xbox games and hardware, and Surface devices -- also benefited from stay-at-home measures.

In short, Microsoft's strengths offset its weaknesses, and maintaining that balancing act allowed it to expand its ecosystem with loss-leading strategies -- like bundling Teams as a free service for Office 365 users.

Microsoft estimated its revenue would rise 8% to 9% annually in the first quarter of 2021 but didn't offer clear guidance for the rest of the year. Analysts expect its revenue and earnings to rise 10% and 12%, respectively, as the growth of its cloud services and the upcoming launch of the Xbox Series X offset the softness of its macro-sensitive businesses.

The long-term winner: Microsoft

Zoom's stock still has a lot of momentum, but its valuations are too high, and the competitive threats are too great to ignore. It might be a good short-term play, but its long-term growth is too difficult to predict.

Microsoft is a more balanced investment. The "mobile first, cloud first" strategies, which CEO Satya Nadella spearheaded six years ago, are still generating strong returns; it's well diversified across multiple markets; and it rewards patient investors with a 1% yield and consistent buybacks.

For now, Microsoft is the better overall investment for long-term investors. I admire Zoom's robust growth, but I'm not convinced it can maintain its momentum and meaningfully widen its moat against its larger rivals.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Cisco Systems and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Facebook, Microsoft, and Zoom Video Communications and recommends the following options: short August 2020 $130 calls on Zoom Video Communications, long January 2021 $85 calls on Microsoft, and short January 2021 $115 calls on Microsoft. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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