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%.
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.
