In retrospect, investors should have seen it coming. The old cliche “expect it when you least expect it” applies to stocks as much as it does anything else, and the 165% gain Roku (NASDAQ:ROKU) shares had dished out between early April and late September certainly left the Roku stock price vulnerable to some profit-taking.
Yet, somehow the 13% pullback from that peak caught too many traders unaware, leaving all of them uncertain as to what’s next. This wasn’t part of the plan.
With that as the backdrop, there’s good news and bad news about Roku. The good news is, this is still the same great company it was just a few months ago. The bad news is, that may not be enough to stop the selling anytime soon.
Roku stock and Story Risk
Some investors struggle to admit it, but more often than not they’re looking through a trading lens. That is to say, they’re looking to time their entries and/or exits, and expect big gains in short periods of time.
It’s this mindset that spurred the heroic gain that unfurled between April and September. Despite a lack of actual profits and sales that were nowhere near being commensurate with the stock’s price, the market had no problem bidding ROKU up on the mere concept.
After all, it enjoys more TV set-top box market share than Apple (NASDAQ:AAPL) and the Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) Chromecast combined. That has to count for something, right?
And to be fair, that does indeed count for something. There are limits, however.
Reality: Roku is expected to lose $13.4 million this year, on revenue of $722 million. For perspective, Roku currently sports a market cap of $7.1 billion. That’s not valuation math that would fly for many other companies.
Things are getting better. The pros are calling for a loss of $3.4 million next year, in anticipation of a top line of $981 million. The 2020 revenue outlook of $1.3 billion should be enough to pull Roku into the black, to the tune of $75.5 million.
Even with that full-stride 2020 bottom line though, Roku stock is still priced at 94 times its way-forward-looking earnings. It’s unlikely traders will be interested in keeping ROKU propped up in the meantime for earnings that still won’t justify its current price.
That’s not to suggest Roku shares will dwindle for the next several years. One only has to look at a name like salesforce.com (NYSE:CRM), GrubHub (NYSE:GRUB) and dozens of others to appreciate traders make valuation allowances for the right kinds of so-called “story stocks.” Roku stock is just as storied.
The thing about story stocks is, when the tide turns, it really turns, even if only temporarily… which brings us to the chart.
Lines in the Sand
In a perfect world a stock’s price would always reflect the consensus plausible future based on past results.
We don’t live or trade in a perfect world though. Stocks get squirrelly from time to time.
That’s not entirely a bad thing. When a stock is being pushed around by a sentiment-driven herd, the herd moves in fairly predictable patterns. Roku shares haven’t been an exception to this norm. Already ripe for some selling, the sheer speed and scope of the selling since late last month may well have kick-started a fear-driven selloff. The sellers thus far haven’t looked back.
And where might those sellers finally start to ease off, setting the stage for a bottom that would make for a good entry point? There are several possibilities, one of which is the 50-day moving average line plotted in purple on the chart below. The 50-day moving average was a key technical support level in July.
Click to Enlarge
The other potential lines in the sand are the horizontal Fibonacci retracement lines also plotted on the graphic. One is near $59, and the other is at $47.50.
It won’t be clear which, if any, of those lines are going to serve as a pivot point until ROKU stock has had a chance to dance with them for a couple of days.
It would also be short-sighted to pretend the marketwide weakness didn’t have a lot to do with this sudden meltdown from Roku.
Bottom Line for Roku Stock
It’s not a mainstream analysis. Most analysts either deem a stock as worth owning or not worth owning and model an often-arbitrary price target for it. The environment and short-term sentiment generally isn’t part of the equation. And for true long-termers, that’s perfectly fine.
For most active investors though, this is a dynamic that matters. Ignoring it could mean hanging on to a stock a little took long, or missing a chance to step into a stock like Roku on the cheap. Just be smart, and disciplined, if you’re planning on going fishing in the foreseeable future.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.
