Roku (NASDAQ:ROKU) saw its stock rocket higher last week as the company beat both earnings and revenue estimates. The stock, which has traded as low as $15.75 per share in the previous year, has reached highs exceeding $60 per share following the earnings beat.
I also credit CEO Anthony Wood and Roku’s management team for their accomplishments. Given its size, its ability to achieve high subscriber growth while competing with Amazon and Google deserved the accolades and attention the company is receiving.
It has also positioned itself to benefit from the growth of streaming, which appears to have become the future of video-based programming.
However, despite the accomplishments, I see issues that could negatively affect the long-term growth of ROKU stock. Investors should remain hesitant to buy for these three reasons.
Negative Earnings Per Share (EPS)
No doubt the break-even quarter boosted confidence. Q2 earnings of zero beat expectations of a 15-cent-per-share loss. For a company that previously had never earned a dime, this stands as a huge accomplishment.
Still, analysts do not expect the company to earn a full-year profit until at least 2020. Even if that profit estimate holds, the company must rely on outside funding sources for the next two years.
Looking at the Statement of Cash Flows, it shows “other financing sources” as the source of revenue in recent quarters. Such undisclosed sources tend not to reassure investors, although it appears to have diluted shares. Recent gains create further incentive for the company to dilute the stock, which bodes poorly for current investors.
Admittedly, this problem could become the easiest to solve. If the company continues to beat expectations, profits could come faster. Or market conditions could turn for the worse, deferring annual profits for a longer time. Whatever occurs, losses and funding will add uncertainty to ROKU stock for the foreseeable future.
Given the recent surge in the ROKU stock price, lofty valuation metrics begin to become a concern. As previously mentioned, analysts do not expect to see a profit until 2020. Even if that predicted 41-cent-per-share figure holds, it places the stock’s 2020 price-to-earnings (PE) ratio at over 130.
Other metrics point to a lofty valuation. ROKU stock currently trades at 9.8 times sales. The stock’s market cap also stands at 28 times its book value.
Over the last few years, investors have shown a willingness to forgive high valuations in the face of growth. With 93.7% growth predicted this year and 71.4% estimated for next year, such forgiveness will likely continue.
Still, such multiples turn a purchase of ROKU stock into a bet that the buyer can later find a seller willing to pay a higher price. Such situations can exist for a time. However, history has shown that these circumstances do not last forever and turn at unexpected times.
Can one buy here and sell at a profit later? Possibly. However, at these levels, buyers are not investing, they are betting.
Of all the problems, the long-term threat to the company’s competitive moat remains its most serious threat. So far, Roku has succeeded in holding the highest market share in the streaming business. However, Amazon, Alphabet and Apple also sell streaming devices.
Size places Roku at a huge disadvantage. Roku’s market cap stands at around $5.9 billion. Unfortunately, Roku also contends with the misfortune of competing with the three largest companies in the world. Apple’s net income in the previous quarter alone exceeded Roku’s market cap.
The prospect that any of these companies would simply let Roku keep this business remains doubtful. In time, at least one company will attempt to compete more aggressively in this space. Roku will probably not be able to respond when this happens. Also, given the lofty valuation of ROKU stock, competing by buyout becomes a less appealing option.
Furthermore, nothing proprietary exists about streaming capabilities. Given the growth in streaming, television manufacturers have simply added that capability into their new sets.
Some choose to partner with Roku, but some can choose another company or offer streaming on their own. Although the company maintains its moat for now, it will probably not hold in the face of all its competitors.
Bottom Line on ROKU Stock
Although ROKU stock continues to perform well amid daunting challenges, it faces three serious headwinds that bode poorly for its future.
Continuing losses make the stock an easy target for dilution. Moreover, the massive increases that began last year have taken its valuation to unsustainable highs. Finally, even if it overcome those challenges, Roku will struggle to position itself to compete with the world’s three largest companies in the long run.
For now, I admire what Mr. Wood has done to compete against his much-larger peers and claim the largest market share in the streaming market. Given the growth in streaming, Roku should continue to improve its performance in the near term.
Still, Roku holds a weak hand. Considering the multiple options customers can choose for streaming, I do not see how Roku maintains its moat in the long run.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.