Shares of Roku (NASDAQ:ROKU) have been on fire in 2019 as the company has not just proven, but also expanded, its dominance in the secular-growth over-the-top (OTT) video market. Year-to-date, on the back on two strong beat-and-raise earnings reports, Roku stock is up more than 200%. In other words, shares have more than tripled in just five months.
That’s a huge rally. But as we all know, securities don’t go up in straight lines forever. Thus, the natural question here is how much higher can the Roku stock price go?
In the long run, much higher. I’ve been bullish on ROKU stock for a long time. This company is turning into the cable box of the OTT world, and the OTT channel is the future of visual-entertainment consumption. Thus, Roku turning into the cable box of the OTT world implies huge streaming-video-on-demand (SVOD) and advertising-video-on-demand (AVOD) revenues at scale.
Meanwhile, gross margins are high and opex rates will naturally fall with scale. Thus, in the long run, this company has tremendous profit potential. That translates to the Roku stock price ultimately running toward $150 or higher within the next few years.
But in the short run, shares of ROKU may be close to peaking. The equity has come very far, very fast. It’s technically trading in overbought territory and is arguably fundamentally overvalued as well. Plus, broader financial market conditions are deteriorating. If this deterioration persists, you could see some widespread profit-taking.
Overall, then, my stance on ROKU stock is pretty simple: long-term bullish, near-term cautious. How does that stance translate into investment action? Do some profit-taking here. But don’t sell everything. Keep the core position, and buy back what you sold here on the next big dip.
Roku Is A Long-Term Winner
In the big picture, Roku has a tremendous ability to scale profits over the next several years. That potential will ultimately push the Roku stock price way higher than where it is today.
Broadly, every consumer is pivoting from traditional TV to OTT TV because the OTT channel offers multiple convenience and price advantages. Simultaneously, content providers are chasing this consumption pivot, following
Netflix’s (NASDAQ:NFLX) example and creating their own streaming services. The net result is that you have a surge in both supply and demand in the OTT video marketplace. Someone needs to aggregate and curate all that supply, connect it to all that demand, and do so without bias.
In comes Roku. ROKU is a streaming service aggregator that connects the big supply in the OTT video market to the immense and still growing demand. Importantly, Roku is largely content neutral, so there’s no bias in the aggregation and curation, implying higher consumer convenience than what is offered at competitors with content biases.
Because of this content-neutrality positioning — and due to its already-huge nearly 30 million active accounts base — Roku is today and projects to remain the cable box of the OTT video market. This has massive implications.
We are talking a market that is quickly marching towards one billion global OTT video subs. Roku could easily grab 10% of that market within the next few years, implying 100 million accounts. Average revenue per each one of those accounts will march higher as subscriptions per account rise, and as advertising dollars continue to flow into the OTT video channel. Gross margins will remain robust near 70%. Opex rates will fall with scale.
All told, I think Roku could do $5 or more in earnings per share one day. A big-growth type multiple around 30-times forward earnings on $5 implies a future potential price target of $150 or higher.
A Near-Term Headwind Is Approaching
In the long run, Roku stock will continue to climb towards $150 or higher, due to secular tailwinds. But in the near term, the stock looks like it may be approaching a top.
I reasonably think $5 in EPS is doable by fiscal 2025. Thus, a $150 price target is fundamentally supported in 2024. Using a 10% discount rate, that implies a fundamentally supported 2019 price target in the lower $90s. That’s roughly where the Roku stock price trades today, and we aren’t even halfway through the year. Thus, long-term growth fundamentals imply that ROKU is stretched here.
Further, shares have tripled in five months. The law of financial gravity tells us that a pullback is overdue. The Relative Strength Index on the stock is in overbought territory, and near all-time highs. ROKU also trades 60% above its 200-day moving average, matching the most this equity has traded above its moving averages, ever. First-quarter earnings have already been reported, and we are now entering a lull in company-specific financial news flow. Plus, broader market conditions are deteriorating thanks to escalating trade tensions.
Ultimately, that combination implies that ROKU stock has hit a peak and requires a correction.
Bottom Line on Roku Stock
In late 2018, the market forgot that Roku stock was a long-term winner. But fast forward five months: the market has remembered to the tune of a three-fold increase.
In the long run, ROKU stock will head higher. Prices above $150 seem doable within the next few years. But in the near term, shares appear overbought and slightly overvalued, meaning that they may struggle to head significantly higher over the next few months.
As of this writing, Luke Lango was long ROKU and NFLX.
