Better buy: Zoom Video Communications vs. Alphabet

Which household tech name will generate bigger returns over the next few quarters?

| More on:
Business people in an office holding a Zoom meeting

Image source: Zoom

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

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

Zoom Video Communications' (NASDAQ: ZM) stock soared about 660% this year as the COVID-19 crisis brought millions of new users to its video conferencing platform. Just as Google became a verb for online searches, Zoom became synonymous with video calls.

Meanwhile, shares of Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL), the parent company of Google, rose just over 10% this year as companies purchased fewer ads during the coronavirus pandemic.

Zoom had a great run, but will it continue to outperform Alphabet over the coming year? Let's dig deeper into both companies to find out.

Zoom: Breakneck growth with a cloudy future

Zoom operates a "freemium" business model, in which free users can upgrade to paid tiers to remove time limits, host more people per meeting, gain cloud storage tools, and unlock other perks.

Zoom's revenue rose by 88% in fiscal 2020, which ended in January, and its adjusted earnings per share (EPS) soared 483%. But in the first half of fiscal 2021, its revenue jumped 270% year-over-year as more people used Zoom for remote work, online education, and staying in touch with friends and family members.

That triple-digit revenue growth easily outpaced its operating expenses, and its adjusted EPS grew tenfold. Zoom expects its full-year revenue to rise 281%-284% as its adjusted earnings rise sevenfold. After that growth spurt, analysts expect Zoom's revenue and earnings to rise 31% and 15%, respectively, next year.

Those growth rates are impressive, but Zoom faces three main challenges. First, a growing number of competitors – including Cisco's Webex, Google Meet, and Facebook's Messenger Rooms – could pull users away from Zoom. These larger competitors can all afford to undercut Zoom's prices, or even offer the same services for free.

Second, Zoom struggled with several security and privacy debacles over the past year. It's resolved most of those issues, but future blunders could tarnish its brand and benefit its competitors.

Lastly, it's unclear if Zoom's usage rates will remain stable after the pandemic passes, or if they'll fall off a cliff after people return to work and school. This makes it difficult to tell if Zoom's frothy forward price-to-earnings (P/E) ratio of 159 is sustainable.

Alphabet: A temporary slump with a clearer future

Alphabet's revenue rose 18% last year as its earnings grew 12%. But in the first half of 2020, its revenue only rose 6% year-over-year and its earnings declined 16%.

A laptop user conducts an online search.

Image source: Getty Images.

That slowdown was caused by Google's sluggish ad sales, which grew less than 1% year-over-year in the first half of the year but still accounted for 80% of Alphabet's overall revenue. The loss of that higher-margin revenue, along with the growth of lower-margin segments like YouTube and Google Cloud, reduced Alphabet's margins and profits.

Analysts expect Alphabet's revenue to rise 7% this year, but for that margin pressure to reduce its earnings by 9%. But looking further ahead, they expect its revenue and earnings to grow 21% and 27% respectively, as the pandemic passes and ad purchases accelerate again.

That outlook seems clearer than Zoom's, but Alphabet also faces three main challenges. First, it faces several antitrust probes across the world, which could result in hefty fines and throttle its ability to expand its search, advertising, and mobile ecosystems.

Second, Google still faces intense competition in the advertising market from Facebook, which leads the social media market, and Amazon.com, which is turning its e-commerce marketplaces into advertising platforms. Google has repeatedly failed to crack both the social media and e-commerce markets.

Lastly, Google controlled just 6% of the cloud infrastructure market in the second quarter of 2020, according to Canalys, putting it in a distant third place behind Amazon Web Services (AWS) and Microsoft's Azure. To remain competitive, Google will likely need to ramp up its cloud spending – which could dent its margins.

Alphabet's stock trades at a reasonable 27 times forward earnings, but it's easy to see why the bulls didn't love this stock as much as Zoom.

The verdict

Alphabet is still a sound long-term investment, but I believe Zoom will generate bigger gains over the following year for one simple reason: The COVID-19 pandemic is far from over, and a second wave of infections could shut down businesses and send people home again.

Therefore, Wall Street's estimates could be too low for Zoom and too high for Alphabet, which will suffer slower ad growth if the pandemic worsens. Zoom's premium valuation would be justified in this scenario, while Alphabet would deserve to trade at a much lower multiple.

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

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. 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 Amazon, Cisco Systems, and Facebook. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Facebook, Microsoft, and Zoom Video Communications and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, short January 2022 $1940 calls on Amazon, and long January 2022 $1920 calls on Amazon. The Motley Fool Australia has recommended Alphabet (A shares), Alphabet (C shares), Amazon, Facebook, and Zoom Video Communications. 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.

More on International Stock News

A male investor sits at his desk looking at his laptop screen holding his hand to his chin pondering whether to buy Macquarie shares
International Stock News

If you invested $10,000 in Nvidia stock the day ChatGPT came out, this is how much you'd have today

Buying Nvidia when the disruptive AI chatbot launched would have been a smart move.

Read more »

A Tesla car driving along a road at sunset
International Stock News

Why Tesla stock was climbing today

Investors were encouraged by news of a price hike on the Model Y.

Read more »

Plate with coloured wedges being parcelled out like a slice of pie representing a share split
International Stock News

Stock-split watch: Is Nvidia next?

Nvidia last split its stock when it traded for a pre-split $744 in 2021.

Read more »

A woman in jeans and a casual jumper leans on her car and looks seriously at her mobile phone while her vehicle is charged at an electic vehicle recharging station.
International Stock News

1 Wall Street analyst thinks Tesla stock is going to $125. Is it a sell?

Tesla is no longer a magnificent stock, according to a Wells Fargo analyst.

Read more »

A young man goes over his finances and investment portfolio at home.
International Stock News

Is Nvidia stock a buy?

The company's stock could rise 40% over the next two years and outperform the S&P 500.

Read more »

Man with hands in the middle of two items with money bags on them.
International Stock News

Is Nvidia headed for a stock split?

Nvidia stock has split five previous times in the company's history.

Read more »

Digital rocket on a laptop.
International Stock News

Nvidia shares surged (again) today. Is it too late to buy the red-hot artificial intelligence (AI) growth stock?

Nvidia stock has gained nearly 300% over the past year. Can investors still profit from this AI stock?

Read more »

A woman holds a soldering tool as she sits in front of a computer screen while working on the manufacturing of technology equipment in a laboratory environment.
International Stock News

Can you buy Nvidia shares on the ASX?

This stock has rocketed higher. How do we get access to it?

Read more »