It’s Time for ROKU Stock to Hit Pause on Its 2019 Rally

The long-term narrative is still very much intact for ROKU

I’ve been a big bull on shares of streaming device maker Roku (NASDAQ:ROKU) since late 2018, a stretch during which ROKU stock has more than tripled. The company has reported monster quarter after monster quarter, reaffirming that this company is on a long-term winning trajectory in the streaming-video-on-demand (SVOD) space.

Here's Why Patience is the Best Call for Roku Stock
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But over the past two months, I’ve warned that valuation may ultimately put a pause in this ROKU stock rally. Specifically, I’ve said that ROKU stock is fairly valued around $100, and that rallies towards $110 should be faded, while dips towards $90 should be bought.

Today, ROKU stock trades at $110. It’s up big over the past few weeks on the heels of a favorable market share update from Strategy Analytics and strong Prime Day sales. But, the long-term upside implications of those catalysts are arguably already priced into the stock at $110.

As such, I’m reaffirming that ROKU stock is a long-term winner which, at $110 in mid-2019, needs to take a breather.

Roku Stock Is a Long-Term Winner

Roku’s long-term growth potential paves a viable pathway for ROKU stock to be a long term winner.

According to Internet World Stats, there are about 4.4 billion internet users in the world (~57% of global population). Assuming a global average household size of 3.5, that means there are about 1.3 billion internet households in the world. Of those 1.3 billion internet households, 300 million of them are SVOD households (about 23-24%). Of those 300 million SVOD households, 27 million of them have a Roku device (~9% market share).

All of those metrics will go up over time.

Global population will go up. The global internet penetration rate will rise as emerging markets continue to urbanize, leading to a rise in the number of global internet people and households. The SVOD penetration rate will similarly rise as internet households continue to shift from linear to internet TV given convenience and price advantages. Further, Roku’s market share in the SVOD market will similarly go up because the platform is content neutral, has an easy-to-use UI, and is the smart TV leader.

Broadly, then, I think the following are very reasonable assumptions by 2025:

  • Global internet penetration rises to 70%. The number of global internet households hits roughly 1.6 billion.
  • SVOD penetration rises to 40%. The number of global SVOD households hits roughly 650 million.
  • Roku’s market share rises to 15-20%. The number of worldwide active Roku accounts hit ~115 million.

ARPU will continue to rise, too, thanks to the growing number of subscriptions per account and a secular rise in OTT video ad spend. Gross margins will remain high thanks to the shift to Player revenues. Opex rates will fall with scale, and operating margins will rise dramatically.

These assumptions pave a viable pathway towards $5.50 EPS for Roku by 2025. Based on a 30-forward multiple, that yields a 2024 price target for ROKU stock of $165.

Stretched Valuation Will Limit Near-Term Upside

The above narrative and math strongly support the notion that Roku stock is a long-term winner. But there’s one problem with buying into this long term winner at current prices: valuation.

With the stock trading at $110, ROKU stock is trading in fairly valued to slightly overvalued territory. If you take the fundamentally supported fiscal 2024 price target of $165 and discount it back by 10% per year, you arrive at a fiscal 2019 price target of $100. Thus, long-term growth fundamentals imply that ROKU stock is trading 10% above its fiscal 2019 price target, and we are only halfway through 2019.

To be sure, momentum can often outweigh fundamentals in the near term. ROKU stock has a ton of upward momentum right now, boosted by strong Prime Day sales and positive market share reports.

But this momentum is fickle, and it can change on a dime. Just see how volatile ROKU stock has been since inception.

As such, with ROKU stock, the best thing to do is stick with the fundamentals, and the fundamentals say wait to buy more until you get another dip in the stock.

Bottom Line on ROKU Stock

ROKU stock is a long-term winner that you want hold onto for the long haul. With these types of stocks, what you want to do is accumulate a core position at a reasonable price, add on big dips, and sell on big rallies.

Right now, ROKU stock is in the the middle of a big rally into fundamentally unsupported territory. As such, I think this recent rally is an opportunity to do some trimming. The stock should come back in over the next few weeks, and when it does, that’ll be the time to buy more.

As of this writing, Luke Lango was long ROKU. 

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