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What Zoom Video Communications, Inc.'s (NASDAQ:ZM) 25% Share Price Gain Is Not Telling You

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Zoom Video Communications, Inc. (NASDAQ:ZM) shares have had a really impressive month, gaining 25% after a shaky period beforehand. Still, the 30-day jump doesn't change the fact that longer term shareholders have seen their stock decimated by the 65% share price drop in the last twelve months.

Following the firm bounce in price, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 15x, you may consider Zoom Video Communications as a stock to avoid entirely with its 27.3x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

With earnings growth that's superior to most other companies of late, Zoom Video Communications has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for Zoom Video Communications

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If you'd like to see what analysts are forecasting going forward, you should check out our free report on Zoom Video Communications.

Is There Enough Growth For Zoom Video Communications?

The only time you'd be truly comfortable seeing a P/E as steep as Zoom Video Communications' is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company grew earnings per share by an impressive 40% last year. The strong recent performance means it was also able to grow EPS by 25,119% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 16% per annum over the next three years. With the market predicted to deliver 11% growth each year, that's a disappointing outcome.

In light of this, it's alarming that Zoom Video Communications' P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

The Final Word

Zoom Video Communications' P/E is flying high just like its stock has during the last month. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Zoom Video Communications currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 1 warning sign for Zoom Video Communications you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E below 20x.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.