Analysts Sour As This One Time High Flyer Founders
Analysts tend to follow the trend so their calls will often reverse when a trend is well underway. That could be happening now as Benzinga recently reported, “Zoom Video Communications Inc. (NASDAQ: ZM) lost a bit of the zoom in its growth trajectory in the third quarter, spooking investors. Sell-side analysts said the company’s communications story remains strong, though the stock price may already reflect it.
Investors weren’t very forgiving despite the beat, selling the stock off even after the sales and earnings beat.
Morgan Stanley’s Meta Marshall kept an Equal-Weight rating on the stock with a $75 price target.
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Credit Suisse Analyst Brad Zelnick remained Neutral and lowered the target price from $90 to $80.
Baird analyst William Power reiterated an Outperform rating, but with a target price lowered from $100 to $85.
KeyBanc’s Alex Kurtz kept a Sector Weight rating on the stock.
Zoom Video reported third-quarter EPS of 9 cents, beating the Street’s 3-cent estimate, while sales of $166.6 million beat the $154.8 million Street estimate.
While Zoom’s 85% year-over-year growth rate in the third quarter sounds pretty good, analysts had expected something closer to 90%. Still, Marshall said the stock price could continue to rise on continued traction in the upmarket segment of video conferencing, leading sales efficiency and the early traction the company is seeing with its new Zoom Phone system.
Zelnick liked the momentum with Zoom Meetings and opportunity for Zoom Phone and Zoom Rooms, but said the price is too high.
“We remain Neutral, due to ZM’s premium valuation, high embedded expectations, and increasing (customer acquisition cost) as the company expands into Zoom Phone,” Zelnick wrote.
Marshall said Zoom has the best qualitative business in Morgan Stanley’s unified communications coverage group, with strong margin potential and a good macro environment, all things reinforced by the company’s third-quarter print.
But he’s remaining Equal-Weight on the premise that share value builds in that appreciation on the market as well.
“If there was an overcorrection in the market from an expectation shortfall, we could become more positive, particularly in early FY21 as Zoom Phone international features become more robust, meaning Phone could become a stronger growth driver,” Marshall wrote.”
Not all analysts are bearish. “Zoom Video’s revenue was short of the previous two quarters, driving weakness in the stock, said Baird’s Power. But, the “combination of growth and profitability stand out from the crowd.”
Bottom line for KeyBanc’s Kurtz: the success of Zoom is built into the stock price. He noted Zoom is trading at a 36% premium to growth peers. He also said that while Zoom Phone could be a long-term growth opportunity, he expects “little impact” in the near term.”
AM is now near its IPO price.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in ZM
For ZM, we could sell a January 17 $60 call for about $5.50 and buy a January 17 $65 call for about $2.95. This trade generates a credit of $2.55, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position in ZM results in immediate income of $255 The credit received when the trade is opened, $255 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $245. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($255).
This trade offers a potential return of about 104% in of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if ZM is below $60 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $245 for this trade in ZM.