Popular lockdown stocks – opportunity ahead?

The pandemic created unprecedented market conditions. Some previously middling, or even unheard of, companies saw their values shoot up as retail investors became excited by their potential.

But investing in something just because it’s popular is not something we’d recommend. It’s important to put your money into companies you understand, and at a price you’re comfortable with. You wouldn’t buy a new car with any old price tag, after all.

With that in mind, now feels like the right time to have a look at three of lockdown’s popular stocks, and assess where they are now and opportunities for growth from here.

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Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

This article is not personal advice, if you’re unsure whether an investment is right for you, seek advice. All investments and any income they produce can fall as well as rise in value, so you could make a loss. Past performance is not a guide to the future.

Zoom – you can’t argue with a 300% revenue hike, or can you?

This one doesn’t need too much introduction. Most of us used it for quizzes, work meetings and Friday night drinks in the height of lockdown.

And it’s hard to knock progress. During the pandemic, Zoom’s annual revenues shot up over 300%. Operating profits came along for the ride too, rising rapidly from £88.7m to £983.3m.

That’s partly because of Zoom’s main attraction – its Software as a Service model, or SaaS. That meant despite its exponential revenue growth, margins more than doubled, and are still sitting around the 30% mark. Adding a new subscription to a SaaS platform like Zoom costs next to nothing.

The path from here does hold some challenges. Margins are expected to dip because the group needs to spend heavily to keep hold of market share. There’s plenty of competition in the space, like Microsoft Teams. So, while we agree the spending is needed, it’s going to be a while before we know if the investments are paying off.

The strength of current margins means Zoom can more than stomach a spending spree, but it’s something to keep in mind.

Zoom operating margins

Past performance is not a guide to the future. Source: Refinitiv Eikon, 01/04/22.

There’s another red flag. Billings are expected to fall year-on-year, which is a negative development. The very appeal of subscription-based operating models is that revenue should be sticky.

The group’s returning $1bn to shareholders via a share buyback. This shows management believe the stock is undervalued (more on that later). At this critical time, we’d rather see that money pumped back into the business to propel growth, but it does mean investors are being rewarded for their patience.

On the valuation, the shares now trade hands for around 35 times expected earnings. That’s much lower than the highs seen when the group first listed, partly because the valuation was artificially high at first. But the market’s downgrading of Zoom’s valuation now makes it interesting.

The fact is, we live in a world where Zoom has become part of the everyday. But maintaining its competitive edge is far from guaranteed – just ask Skype.

SEE THE ZOOM SHARE PRICE AND CHARTS

Peloton – how far until the (cycle) path to profitability?

Peloton provided a solution for those mourning the closure of gyms and exercise classes during lockdown. Slick marketing and a strong fanbase meant the group did exceptionally well.

Part of the group’s appeal was that it didn’t just offer the infamous Peloton bike. It also offered users an immersive – and very lucrative – subscription to classes. Peloton’s revenue during the pandemic more than doubled to $4.0bn.

That’s testament to the group’s strong brand and genuine appeal, which shouldn’t be knocked. But Peloton is having to peddle very hard. Along with those extra sales came huge hikes in costs. Research and development spending more than tripled to $210.7m last year.

All-in-all, that means the group doesn’t currently generate any profit and is heavily loss making. A pattern that’s expected to continue for now, despite revenue climbing. This is our biggest concern where Peloton is concerned. Conditions are unlikely to ever be as supportive as they were during the pandemic, so if turning a profit now is a challenge, we wonder when it will happen.

Inflation is worth a mention too. The so called ‘basic’ Peloton bike starts at £1,550, so quickly falls into the ‘luxury item’ category. As household budgets around the world, including in the US which accounts for 93% of Peloton’s revenue, feel the pinch, suddenly shiny new gym equipment loses its appeal.

Peloton 2021 revenue

Source: Refinitiv Eikon, 1/04/22.

Peloton’s lack of earnings makes it hard to value using our preferred metrics. But it’s encouraging to see the valuation on a price to sales basis come down to a sensible level of around 2.6.

Peloton could stand to benefit from a long-term shift in demand for at-home workouts, and be worth attention for those with a higher-risk appetite. For now, we’d prefer proof the group’s on the path to profitability.

SEE THE PELOTON SHARE PRICE AND CHARTS

Netflix – not so chilled

Netflix pulled in an unfathomable number of subscribers over the pandemic, with 37m new additions over 2020. This was thanks to Netflix’s strong brand and attractive suite of content.

Volume of online content being watched

Source: Statista, February 2022.

Of course, on one hand, the acceleration of streaming culture is a good thing for the company that had a hand in inventing it. But the initial spikes in Netflix’s share price over the pandemic came from this surface level assessment. The reality is this huge acceleration of growth caused two problems for Netflix.

The first was we all burned through content much faster than planned. I bet none of us were thinking about the headaches we were causing Netflix HQ when we all sat down and binged through Tiger King in a day.

This of course came at the same time as expensive production sites being shut down. That meant in the year after everything opened up, the group’s already hefty content bill shot up 18% to $14bn.

The second is that growth was simply pulled forwards. If you didn’t get a Netflix subscription when confined to your sofa, chances are you never will. That’s why Netflix now expects subscriber numbers to grow just 2.5m over the current quarter, down from 4m the previous year – something the market didn’t respond to very well.

This is a particularly sensitive topic because of rising competition. The likes of Disney+ are poised to take market share.

However, we think the market’s harsh reaction might be overdone. The media giant now changes hands for a shade over 32 times expected earnings. That doesn’t necessarily reflect the group’s strengths.

Growth is going to be harder to come by, but Netflix still has room to run in our opinion. Investors should, as ever though, be prepared for some ups and downs.

SEE THE NETFLIX SHARE PRICE, CHARTS AND OUR LATEST VIEW

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Unless otherwise stated, estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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