Zoom's Growth Is Slowing but It's Not Done – The Motley Fool

In this podcast, Motley Fool senior analyst Matt Argersinger discusses:

• Zoom Video Communications‘ slowing revenue growth.
• How Zoom’s brand gives it an advantage against bigger competitors.
• Target beating expectations and reporting better management of its inventory.

Motley Fool host Alison Southwick and Motley Fool personal finance expert Robert Brokamp take a closer look at tech layoffs in 2023 and one company that’s managed them well. 

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Feb. 28, 2023.

Chris Hill: We’ve got more retail, more layoffs, and for anyone who’s interested, a deep dive on dividend investing, Motley Fool Money starts now. I’m Chris Hill joining me today, Motley Fool Senior Analyst Matt Argersinger. Thanks for being here.

Matt Argersinger: You bet Chris.

Chris Hill: Let’s start with Zoom Video, shall we? Because fourth-quarter profits and revenue were higher than expected, revenue was up, but it was only up 4% compared to a year ago. This continues the trend that we’ve seen for a while from Zoom Video which is they’re growing, but it’s slower growth than we’ve seen in the past.

Matt Argersinger: I know it’s hard to imagine a company like Zoom Video growing revenue at just 4% because I think everyone, including me, because I haven’t looked at Zoom very carefully until recently. You assume that it’s still in that high-tech high-growth category — it is. It’s still a very essential technology communications company. But to see revenue just up 4%, it’s amazing to see the slowdown they’ve had. But I think the story of Zoom, it’s one of those ones where so much of its future came within 18 months of when the pandemic hit in early 2020.

It just pulled so much of it forward. The question is it a sustainable business going forward? I have to say the one thing that impressed me about its earnings, if you look at the enterprise customers. I think they had 213,000 enterprise customers served in the fourth quarter. That was up 12% from a year ago. Those customers had a net dollar expansion rate of 115%, which means that, that average big spending, customer is spending about 15% more now than they were a year ago. If Zoom can continue to prove itself out on the enterprise level then I think it has a pretty good future.

Chris Hill: Do you think that Zoom has essentially established itself as the table stakes for this industry? Because it seems to me that if you are in the business of competing against Zoom and not to say that Zoom can’t and won’t be disrupted. But it seems like so many people, enterprise customers, regular, everyday consumers like you and me. Everyone is so much more familiar with Zoom than they are with the alternatives that I think if you’re in the business of competing with Zoom, you have no choice but to put yourself in a position where you can answer questions because anyone who is thinking about spending money on this product, they’re going to be like, well, what are you guys easier than Zoom? Is this like what function that like? I feel essentially whatever happens from here, they’ve established themselves as the go-to and forcing others to explain why they’re better.

Matt Argersinger: I think what you’re getting at, is there, the verb. You Zoom. You meeting Bob this afternoon, you guys going to Zoom? That’s a brand advantage and an identity advantage that I think a major competitor like Microsoft Teams, which of course has made big market share gains, doesn’t quite have that same affinity to it. I think that’s a huge advantage for them. You’re right, it’s like if you are any systems manager at a company and you’re sending your company up for what communication platform is going to be used? Well, that’s going to be the default go-to. It’s going to take more spending, more time looking at other technologies before you go with a different company like Microsoft.

I think the advantage that Microsoft and maybe Alphabet‘s Google have in the space, though, is of course they can add on a bunch of different capabilities and apps that Zoom might not necessarily be able to have. Atlassian is another company that comes to mind which has communication and workflow apps that are very popular. The more Zoom can continue to innovate and they are innovating around the app. I think that’s the key. They got to be stickier. They’ve got to take the advantage they have in brand recognition. Continue to add features and capabilities and continue to make it easy. I think that’s why we all fell in love with Zoom a few years ago. It’s because it’s so easy and it works so well. That’s the table stakes. Now, can you make it as sticky as possible?

Chris Hill: For the first time in a year Target’s quarterly profits came in higher than expected. Sales in the holiday quarter up just 1%. Their guidance is conservative, but I don’t know why anyone would expect their guidance to be anything but conservative given the year that they’ve just had. By the way, given what we saw last week out of Walmart as well.

Matt Argersinger: Home Depot comes to mind as well as I was looking at this. I think Target has some advantages and the sales growth looks anemic and I think the guidance looks really conservative. You’re talking about comparable-store sales growth or declines within low single digits. They’re not sure which, but what they are confident is that they’re going to continue to grow earnings. Earnings growth looks like it’s going to be pretty good this year. They’re managing things on the cost front. I think what I was impressed with most with their quarter was the inventory story for target. It was the inventory at the end of their fiscal year was 3% lower than it was last year.

If you look at Home Depot, for example, their products they’re not exactly as discretionary or as consumable as what Target sells, but their inventory was up 50% year over year. That’s a major problem for them. They lowered the revenue by 3% and the discretionary category particularly was down 13%. They’re managing the inventory well. But there’s two sides to that story. The softness we’re seeing in the discretionary side means, they’re going to see lower margins. It’s going to be tough to turn that around, especially if we have a recession because those are the places were consumers aren’t spending. Food and beverage, household staples, those are going to continue to do well, they’re just lower-margin. The question is, can Target be OK as long as those discretionary categories are not coming back, but they need to come back at some point or earnings and margins are going to come down.

Chris Hill: I’m glad you mentioned the staples because that really was a big part of Target’s story in the fourth quarter, even though it’s the holiday quarter. Household items, health and beauty, groceries, those everyday things. I think if you want to be glass-half-full about the next 6-9 months for Target. It’s that if they can sustain what they’re doing on those household staple fronts. It does provide them the opportunity to maybe pick up and surprise a little bit to the upside on the discretionary side, because you think back to last summer, Matt, and the inventory story was a nightmare. Brian Cornell owned that, the CEO stepping up and just saying like, I blew the mix. We had the wrong mix of stuff that’s on me. Again, probably not a surprise that they’re being pretty conservative with their guidance, but who knows, maybe six months down the road, they’re surprising to the upside.

Matt Argersinger: Yes. I think that’s exactly what they’ve done. They’ve set themselves up for that. They’ve really set themselves up to under-promise and over-deliver with getting the mix right, as you said, which I think was essential. If you’re looking at it as an investor, the earnings story, it looks pretty good for this coming year. If they can do $8 to $8.50 in earnings per share, that’s well above what they did last year. It trades for about 2021 times forward earnings that I’ve seen a lot of investor call Target of a value stock cheap. That’s not exactly a low multiple based on the growth we’re seeing and the risk to that.

Whatever remaining consumer discretionary business they’re going to depend on for growth in the year ahead. But I think what investors can hang their hat on is the dividend. If they’ve got a nice dividend yielding about 2.6% right now. It’s well covered by earnings. There’s an upside there, given the balance sheet and the spread between the dividend and what they’re expecting for earnings per share in the year ahead. You might see some growth there. You can hold on. If you can get the stock a little cheaper, maybe you get roughly a 3% dividend yield. Can stick with that as the business turns around and maybe we avoid a recession and then you’ve got a pretty good investment on your hands.

Chris Hill: On that last point, real quick, last week you and I recorded a video that I want to encourage people to check out. It’s really a deep dive on dividend investing. People can go to masterclass.fool.com. I’ll put the link in the show notes, but this was a really fun conversation for me. Because this is increasingly how I am investing in my personal life. But it was just great to go deep on dividend investing with you.

Matt Argersinger: Likewise, Chris, I really enjoyed the conversation. Dividend investing as you know, and we’ve talked about it over the past year or maybe on the show a few times. Dividend investing has really become the way I prefer to invest going forward. It’s just getting that income focusing on the dividend and the growth of dividend especially the benefits to that as an investor are massive. Then you can build yourself a nice income stream. If you think about the bear market we had in 2022, dividend strategies really outperformed. If you had a core set of dividend stocks in your portfolio, I’m sure your portfolio did a lot better than the overall market, and that’s part of the story. That’s why dividend strategies tend to really outperform over time with a lot less volatility, which I think is a key part of it, too. I love the conversation. I’m glad we had a chance to talk about that and talk about a new service that’s launched this week as well.

Chris Hill: It’s a ton of great information. As Matt said, it’s the launch of a new dividend investing service that he’s going to be heading up. Again, go to masterclass.fool.com. The video is going to be up until midnight, Wednesday, although I’m told that’s midnight on the West Coast. Technically 3 a.m. Thursday for people on the East coast. It’s about 35 minutes, and there’s just a lot of great information there. If you become a member of the service, great if, even if you don’t. I think this is one of the best videos like this that we have produced in a long time. Again, and also Matt shares, one of the stocks that he’s recommending in the service. Definitely worth your time. Masterclass.fool.com. Matt Argersinger, great talking to you. Thanks for being here.

Matt Argersinger: Thank you, Chris 

Chris Hill: So far in 2023, tech companies have shed more than 100,000 jobs. But to layoffs automatically make a company leaner, Alison Southwick and Robert Brokamp, look at the long term effects of layoffs and one company that’s managed them well.

Alison Southwick: I remember early on in my investing journey hearing about how a company it was about to lay off a ton of employees. I don’t remember which company, but I do remember being surprised that the shares shot up as a result of the news. Clearly laying off a ton of employees is a sign that the company is in distress. I was baffled. Why would investors be like, yes, I want to get me some of that. This was the first time I encountered the notion of, well, somebody think of the shareholders that was born in the ’80s and still exists today. Firing people cuts costs, and after all, a CEO’s first and foremost job is to maximize shareholder value. That sounds like something someone would say, well, sipping a martini at 11:00 A.M.

Robert Brokamp: Yes. Well, reciting Gordon Gekko quotes, and it’s true that the ’80s where a turning point. But the intellectual underpinnings of this whole like maximizing shareholder value thing really started in the 1970s with things like a Milton Friedman article written in The New York Times with the headline quote, “The social responsibility of business is to increase its profits.” In 1976, an academic paper with a thrilling title of, Theory of the firm: Managerial behavior, agency costs and ownership structure, was published, and argued that company executives weren’t focused enough on benefiting shareholders. That publication became one of the most cited business academic papers of all time.

Then in the ’80s, some new laws fueled the emphasis on share price. Companies could buy back their own stock. Stock options became a bigger part of executive compensation. IRAs and 401(k)s began to become more widely used by workers. Companies increasingly saw layoffs as a way to prop up share price, at least theoretically, which was not the way they were always viewed. In his book, the Disposable American, Louis Uchitelle wrote that from the 1890s to the 1970s mass layoffs we’re seeing as quote, a sign of corporate failure and a violation of acceptable business behavior. But then that changed. According to Professor Arthur Boudreaux, in 1979, fewer than 5% of the fortune 100 companies announced mass layoffs. But that figure has grown to 45% by 1994.

Alison Southwick: Which brings us to today. The breathtaking amount of layoffs we’re seeing in tech. Zoom laid off 15%, Alphabet 6%, Amazon 5%, Meta 13%, Salesforce, 10%. Adding up just those companies and you’re looking at more than 50,000 employees being laid off. All told we’re talking 100,000 laid off in the tech sector so far this year and closer to 300,000 going back six months.

Robert Brokamp: Have you been invested in these companies like you felt at least some of this pain. The Nasdaq dropped 33% in 2022. It’s third-worst year ever. Many stocks in the funds that invest them dropped far more. For example, Cathie Wood’s Ark Innovation ETF, which has become the poster child for the boom and bust of tech-related stocks plummeted 67% in 2022. Now, so far this year we’ve seen a rebound with the Nasdaq up 9% and that ARK ETF up a whopping 23%, which could be seen as the market giving its blessing to the tech belt-tightening. But as we’ll discuss later, layoffs can actually have mixed results longer term.

Alison Southwick: Why are we seeing historic layoffs in tech? Axios says that while executives are incentivized to blame the economy, the real reason for the mass layoffs is “driven more by market scrutiny of some of the bad ideas tech geniuses have dumped money on in recent years rather than economic fundamentals, those costs are now devour worrying sales dollars that would otherwise turn to profits.” In many cases, tech companies over-hired to feed these initiatives. You’re all listening to the sound of my voice with your VR goggles on while chilling in the metaverse, right?.

No? Well, at least one CEO is blaming himself and his exuberance. Zoom’s CEO wrote in his statement to employees when announcing a 15% reduction, employees, “As the CEO and founder of Zoom, I’m accountable for these mistakes and the actions we take today and I want to show accountability, not just in words, but in my actions.” He then cut his salary pay by 98% and forfeited his bonus for 2023. Now fun fact, Apple also grew in the last couple of years, but at a much slower clip than its tech giant counterparts, by only about 20% compared to Zoom’s 300%. Now, Apple is the only tech company so far that has not announced layoffs.

Robert Brokamp: Apple definitely showed some restraint relative to the other companies. According to CNN Business Microsoft grew its workforce by 50% since the third quarter of 2019, Alphabet by 64% and Amazon and Meta doubled their numbers of employees. Those are sizable increases in headcount for companies that were already pretty big. In some cases, a good bit of it may have been justified or maybe rationalized by increased earnings due to people being stuck at home during the pandemic. We were all sitting around in front of our computers all day browsing and buying stuff. But there are other theories about why this happened.

One of them being labor hoarding, and that’s the idea that you can’t wait to hire the people you’ll need in the future because they may not be available. Instead they’ll be working for your competitors. You have to act now. Some of blame Silicon Valley’s arms race, trying to be the biggest and the best place to work. Probably some empire-building going on and really some plain old peer pressure. When you see other companies acting in one way, you can’t help but question whether you should join in. That works the other way as well as Annie Lowrey of The Atlantic recently wrote, layoffs are contagious. Other companies doing something like laying people off gives you cover to do it at your company as well.

Alison Southwick: Do layoffs work? Well, I guess the question is, what were you hoping to layoffs would accomplish? For this, let’s look to Jeffrey Pfeffer, a professor at the Stanford Graduate School of Business. He says that layoffs do not solve what is often the underlying problem, which is often an ineffective strategy, a loss of market share or too little revenue. Instead, layoffs make your employees nervous and unproductive and you end up hiring people back at a premium later anyway. Well, I’ve got a metaphor. These tech layoffs are like taking aspirin to cure you’re splitting headache after a night of partying. Sure, your head will feel better, but ultimately, you partied too hard and it’s going to take a lot of water and staying in if you want to feel better in the long run and be a fully functioning human being, I mean, tech juggernaut.

Robert Brokamp: It’s also like leaving a mess in the bathroom that someone else has to clean up. Because a slew of studies starting in the 1990s have come to similar conclusions as Dr. Pfeffer. Layoffs can make your remaining employees paranoid, uncreative, risk-averse, overworked, distrustful of management, all of which can lead to higher turnover. Some of your best people might leave, taking institutional knowledge with them. Then you have to spend thousands of dollars to find an odd board their replacements. Also, layoffs are not so great for PR. In the end, the ultimate goal may not be achieved. Some studies have found that layoffs actually had just a small impact on profitability. While the stock price might rise after the announcement, it often eventually drifts downward afterwards.

Alison Southwick: A leading business professor says that layoffs don’t work. While this Jeffrey Pfeffer sounds like a really nice guy who cares about the devastating personal toll layoffs can have on employees physical and mental well-being, that’s great. But me, someone was zero credentials and no expertise in corporate management. I wonder, won’t somebody think of the shareholders? I mean, isn’t there a time and a place for layoffs? If you over-hired then isn’t a good thing to recognize your mistake and walk it back.

Robert Brokamp: I would say yes, especially if you’re unprofitable, no business can go on losing money forever. Now, many of these tech companies are profitable, but that’s a whole other point. But the bottom line is, for most companies, labor is the No. 1 cost right there. The salaries of course, but also the benefits which are worth about 20-40% of what employees receive in their paychecks. If you have to cut costs, laying people off is certainly one way to do it. But I would say put a great deal of thought in what the right size of your company should be in a year or a few. Because if you expect to staff up again in the future, it might be better to keep people on your payroll rather than endure the negative effects of layoffs and the cost of the rehiring. Also, try not to over-hire in the future because getting laid off can be really hard on workers and their families.

Alison Southwick: If you’re one of the many people who have been laid off from a tech company, the good news is that you are still highly employable and you can find comfort in knowing that many economists think you’ll have no problem getting a new job. Now of course, they haven’t met you personally, but they have a lot of nice things to say about your prospects, and Robert and I are rooting for you. Go ahead and put us down as references. 

Chris Hill: As always, people on the program may have interest in the stocks they talk about. The Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. I’m Chris Hill. Thanks for listening. We’ll see you tomorrow.