Roku Inc Stock Has Upside — But It Requires Patience

ROKU stock - Roku Inc Stock Has Upside — But It Requires Patience

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Roku Inc (NASDAQ:ROKU) has had a volatile five and a half months since its late September IPO. The Roku stock price initially dipped after opening higher on its first day of trading. But ROKU stock would triple in barely a month after a blowout third-quarter report.

Since then, however, the Roku stock price has dropped about 36%. And that doesn’t create a clear buying opportunity. Short sellers are targeting the stock. Even with the pullback, valuation looks high. And Q4 earnings, though solid, disappointed investors and led shares down over 20%.

But I wrote after earnings that I rather liked the report, even though I’d been highly skeptical of ROKU stock heading into the release. In fact, I think ROKU is a buy — at some point. With the Roku stock price settling in in the high $30s over the past few weeks, that point may be now. But investors need to be careful — and creative — in trying to find the proper entry point.

Where Roku — and Roku Stock — Go From Here

Obviously, at over 6 times revenue, even backing out cash on the balance sheet, Roku is a dearly valued growth stock. That alone creates uncertainty. Is Roku the next Square Inc (NYSE:SQ) or Shopify Inc (NYSE:SHOP)? In those cases, the story (so far, anyway) has allowed those stocks to continue to rise despite nosebleed valuations. But for recent IPOs like Twilio Inc (NYSE:TWLO) or, going back a few years, GoPro Inc (NASDAQ:GPRO), initial optimism has faded rather quickly.

For stocks like ROKU, it all comes down to the story. And, as I wrote at the time, the reason I liked Roku’s Q4 is that management had a more intriguing story to tell. The current Roku business model doesn’t look like enough to support the current valuation. The player business is unprofitable. The platform business is growing, and high-margin, but gets minimal revenue from Netflix, Inc. (NASDAQ:NFLX) and zero from Alphabet Inc (NASDAQ:GOOGL,NASDAQ:GOOG) unit YouTube.

With the Roku stock price about 11x platform revenue, that’s not a good enough story. But some of Roku’s plans suggest a broader, more viable, business. A home entertainment network — complete with smart soundbars and speakers — could see major demand. (Trying to unify home entertainment has been a goal of many companies, but few have succeeded.) It would make the Roku device — whether a standalone player or a Roku-branded TV — the center of the home, not just the gateway to video content.

The Roku Channel already is seeing some success — and TV networks have real value. Bear in mind that AMC Networks Inc (NASDAQ:AMCX), hardly a dominant media company, is valued at almost $6 billion, including net debt. Even a Roku Channel valued at one-tenth or one-fifth of that company (which includes five networks) adds material upside to ROKU stock, which currently has a $3.6 billion market cap.

And Roku has a huge base — more subscribers already than Charter Communications Inc (NASDAQ:CHTR) and behind only Comcast Corporation (NASDAQ:CMCSA) and AT&T Inc. (NYSE:T). That alone provides additional potential monetization options going forward.

Is the Roku Stock Price Too High?

It’s tough to value growth stocks, since they largely come down to arguments not about what profits are now, but what they might be five or even ten years down the line. And so there’s real risk in ROKU stock in the near term. Short sellers are paying outrageous borrow fees, which implies they see material, and quick, downside. More shares will come to market as lock-ups expire, potentially adding more selling pressure.

If the market sees Roku as a flash in the pan, or simply too small to compete in a world of giants, the Roku stock price will plummet in a hurry. Thus, investors need to be nimble, if not outright cautious, in taking a position. Selling puts provides one potential avenue, bringing in either premium income or buying ROKU at a lower price. The Oct. 30 put provides a roughly 20% return, with downside requiring ownership of ROKU stock at $25.

Or investors simply can wait, and let trading shake things out a bit. Short sellers are going to have to cover at some point, which means the Q1 report due (likely) in early May could see another huge move in the stock price. There’s nothing wrong with taking a small position now, and looking to add on any weakness.

At the end of the day, I do think Roku has an interesting niche in the content world. And there’s a real chance for this to be a stock with huge upside. The company has barely tapped international markets. It’s still learning how to monetize its existing subscribers. And that subscriber base is growing.

This creates a path toward significant upside and, eventually, profitability for Roku, as a company. But that path for ROKU stock no doubt will be bumpy. I like ROKU at these levels, but it’s possible ROKU stock could get even cheaper in the near future.

As of this writing, Vince Martin is long shares of AMC Networks, and has no positions in any other securities mentioned.

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