Cathie Wood is almost certainly wrong on Zoom Stock

Cathie Wood is the head of Ark Invest, an investment company that manages various exchange-traded funds (ETFs). Its flagship ETF is the Ark Innovation ETF (ARKK 3.41%)in which Focus on video communications (ZM 2.31%) stock is the main holding and accounts for almost 11% of the fund.

On June 8, Ark Invest made headlines by predicting that Zoom stock would reach $1,500 per share by 2026, more than 13 bags from which the stock currently trades. I think Wood is almost certainly wrong on that price. But let me explain why I still believe it’s directionally correct and why you should care.

The investment thesis for Zoom

Ark Invest actually has three price targets for Zoom: a bearish case of $700 per share, a mid case of $1,500, and a bullish case of $2,000. These numbers aren’t pulled from nowhere, but rather are based on a series of clearly articulated assumptions about Zoom’s business.

In short, Ark Invest has published an investment thesis – a succinct summary of what it believes will happen to create shareholder value over a period of time. It’s something that all the investor must develop and be able to communicate before investing in any Stock.

To briefly recap, Ark Invest expects mind-blowing revenue growth from Zoom by 2026. Here are the main takeaways from the thesis:

Metric Zoom now (depending on
to Ark Invest)
Zoom in 2026 (Arche
Average case of Invest)
Total number of Zoom users 212 million 291 million
Pay Zoom users 36 million 146 million
Average revenue per paying user $113 annually $356 annually

Data source: Ark Invest.

Ark Invest expects Zoom to increase its revenue sevenfold in four years. This represents approximately a compound annual growth rate (CAGR) of 65% for revenue. For perspective, Zoom management expects revenue growth of 11% this year at best. Therefore, growth is expected to pick up considerably in subsequent years to come within easy reach of Wood’s projections.

In Ark Invest’s model, Zoom would generate approximately $52 billion in annual revenue in 2026 with a free cash flow (FCF) margin of 26% and a market capitalization of approximately $510 billion. The model therefore requires 13.5 billion dollars in FCF, which would be exceptional. And the model expects the stock to trade at 37 times that FCF.

Why I love investment theses

In the short term, stocks are volatile, trading depressingly higher and lower as investor emotions rebound. Zoom stock itself is exemplary in this regard. Since going public three years ago, it has traded at $62 per share, down to $568 per share, and down. Zoom’s business hasn’t fluctuated as much as the market thinks.

Without thesis, investors cannot discern whether things are going well or badly because the stock price is not a reliable short-term indicator. Therefore, an investment thesis provides a tangible measuring stick.

However, every investment thesis will eventually turn out to be somewhat wrong because humans are not omniscient. The same goes for Wood’s thesis on Zoom – at least Something will not go as planned. Specifically, I find it unlikely that Zoom will grow revenue as quickly as Ark Invest forecasts. And a stock trading at 37 times free cash flow (FCF) has a generous valuation. Consider that Zoom stock is currently trading around 20 times its adjusted FCF. This means that Ark Invest expects the valuation to almost double, which seems unreasonable.

Investment theses are often wrong in the details and yet are indispensable. Just ask yourself how many assumptions can be wrong before the thesis is entirely invalidated.

When it comes to Zoom in particular, I agree with many of Ark Invest’s assumptions. For starters, I think Zoom can continue to grow its customer base, as evidenced by how the company continues to add new customers sequentially, even as it sees impressive gains from the start of the COVID pandemic. -19.

Zoom’s customer base also continues to spend more over time. New Zoom products such as Phone and Rooms are driving this expansion and may continue to drive this spending growth in the years to come.

And when it comes to FCF, Zoom has long been a mainstay, with an adjusted FCF margin of 46% in Q1. I think the company will remain strong in this area even if the margin shrinks.

I think Wood’s investment thesis for Zoom shares is aggressive and unlikely to hit Ark Invest’s price target. However, while I don’t think investors should be expecting a 13 sack, I think Zoom can double or more over the next four or five years depending on its business trajectory. This would likely make Zoom an investment that beats the market. And beating the market is what matters.

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