Recently I wrote about Roku (NASDAQ:ROKU) and shared important trading levels that turned out to be spot on. In that article I warned that analysts were a threat to the stock price as they would soon “change that or their rating on it.” This in hindsight turned out to be prophetic.
ROKU had a really tough Wednesday as since yesterday Loop Capital and Mcquarie downgraded the stock. It fell 14% in one day on the headlines. So one would think it’s a disaster, but ROKU stock is still up 90% for the year even after this dip. Clearly this deserves a closer look before catching the falling knife.
It is obvious that Roku is a momentum stock, and it took a rocket ride up — especially after the earnings. So it may have built up a layer of new buyers who chased the stock too late in the game from the fear of missing out. These are the weakest hands in it now, and they pose a threat to the price action.
Loop Capital cut ROKU stock to “sell” with a $45 price target. While the second analyst merely downgraded to “neutral” and raised their price target to $66 per share which is $5 higher than now. This is proof that the matter is still up to debate, and I encourage everyone to trade their own thesis not so called experts.
I profess that my message today will not win me a popularity contest among ROKU fans. But before you send me hate mail, know that I don’t judge the company — I just aim to find proper trading levels. My somewhat bearish opinion of its fundamentals should not sway anyone from owning it for the long term. Meanwhile, I merely point out risks to the price.
Short-term headlines are catalysts but they don’t necessarily change the thesis. ROKU operates in an area that has a bright future. Netflix (NASDAQ:NFLX) proved that we want to stream our content going forward. This is a global trend and one not likely to die any time soon. Media giants recognize this, as is evident from Disney’s (NYSE:DIS) commitment to launching its own streaming service. Roku is poised to play a part in that movement.
The beauty of the ROKU business model is that it is content agnostic. They do not compete with the content providers, but they provide the delivery vessels for what’s available. My problem is with valuation. I believe Wall Street recently over did it on that front. So from that sense I agree with the downgrades from a fundamental perspective.
So for the long term, I am not one to bet on ROKU stock. I don’t think it can grow into its valuation. This is a 16-year-old company that still loses money. So until it shows me either profit or hyper growth I prefer investing elsewhere. However, it’s definitely tradeable.
For a stock that moves this fast, we should find good levels on worthy dips. A 14% fall after a massive 180% rally off the December lows is not deep enough.
Most often, Wall Street overshoots in both directions, but somewhere in the middle always lies the truth. In the last five years, ROKU had two triple digit percentage rallies that ended in severe corrections. It went from under $20 per share to $70 twice and therein lies the risk.
This last poke to the $77 per share level made it a candidate for a double-top meme. Last October, the stock rallied to $77.57 then fell 65% from high to Christmas lows. The rebound from that was even steeper than the prior rally therefore making it even more extreme. So it would not be strange to expect the possibility of history repeating itself. A sharp correction could be unfolding here and could lasts for a few more days.
So, I do not want to be the hero who tries to catch this falling knife. I’d wait for stabilization, and this starts with a troughing process. ROKU would need to stop setting lower lows and build a trend of higher ones until it breaches the upper edge of the descending channel.
In this case and so far we only have two candles, so the price discovery is a work in progress and it may still be too early to buy.
The biggest candle this year was the earnings reaction on Feb. 22 when the stock broke out from the $54 neckline. The target of that bullish pattern has since completely priced out. Now that ROKU is falling, on the way down the neckline which are pivot points act as support. Both bulls and bears who fought over it then would reengage thereby creating congestion. This is also the battle zone from the earnings of last November when the stock fell into a 50% correction that ended in December.
Clearly Wall Street is interested in that level, so I would hold off buying the stock until it gets tested again. The short-term volume profile also suggest that the $50 to $52 zone offers the best short-term support level. Longer term, there is room to fall much further if the bears succeed in their mission.
So, if I am long the stock and I haven’t yet closed my longs, I would wait to see if it can hold $60 per share. If that fails ROKU stock could retest the bottom of the earnings candle so $54 is still in play and $52 would close the earnings gap.
This is not a forecast — I merely point out levels and scenarios that matter. The specific decision on risk management varies from investor to investor, depending on timing and risk tolerances.
If the stock doesn’t rebound soon and retake the recent highs then the shorts will grow bolder, counting on the double top as an absolute roof. Onus is on the bulls to show that they are in charge of that stock but the window for that is small. On the way up the important resistance levels are at $65, $67 and $70 per share.
In my last write up I noted that “As ROKU approaches the $74 area, the threat of a pullback increases.“ And in hindsight, that turned out to be accurate almost to the penny.
Then I also recommended that only those who were nimble enough to snipe the last $4 left in the rally. Else the right thing to do is wait for the breach of $77.50 to chase or a pull back to support. It looks like my plan was the correct one to use. So now it’s a matter of waiting for the support to kick in.
Why bother? Because ROKU stock is a good trading vehicle. Nevertheless, it is also a momentum stock, so it could turn out to be a falling machete with a tiny handle. It would be dangerous to catch it too early.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on Twitter and Stocktwits.
