Roku Inc (NASDAQ:ROKU) stock needs a breather, and it needs one now.
On December 31, 2018, Roku stock was trading at $30.64 and the stock is currently higher by 256% at $110.
The massive rally has been backed by strong business development. However, the stock has come too far, too fast and I believe that it’s the time to stay on the sidelines.
Roku Stock: Valuation and Financials
Roku Inc commands a market capitalization of $12.4 billion with the company expecting to clock a turnover of $1 billion for 2019. At 12 times revenue, the valuation is stretched.
To put things into perspective, Amazon (NASDAQ:AMZN) trades at 4.2 times 2018 revenue. Further, Alphabet (NASDAQ:GOOG) trades at 5.8 times 2018 revenue.
While Amazon and Alphabet are significantly more diversified, the above valuation comparison does indicate that Roku stock is due for correction.
Further, Roku expects 2019 adjusted EBITDA in the range of $10 to $20 million. The company is therefore still some distance away from generating healthy cash flows.
Again, muted EBITDA margin and negative cash flow at operating level is understandable for Roku stock. The company is making significant investments in R&D and marketing. However, the stock might have run up a bit too much in the near term.
Buy Roku on Correction
For a stock that has surged 256%, a correction of 20% to 30% is entirely likely even if business developments remain robust. I believe that any such correction will provide an opportunity for investors to consider fresh exposure to Roku stock.
There are several reasons to be bullish on Roku stock for the long-term.
The first point to note is the positive trend in active accounts that has increased from 20.8 million in 1Q18 to 29.1 million in 1Q19. More importantly, the average revenue per user (ARPU) has increased from $15.07 in 1Q18 to $19.06 in 1Q19.
Therefore, in addition to growth in active users, the monetization through video advertisement impressions and brand sponsorship has been robust. If this trend sustains, it will translate into EBITDA margin expansion once R&D and marketing expenses decline on a relative basis.
Another important point to note is that the shift from linear TV and legacy pay TV services to streaming will sustain in the coming years. The Walt Disney Company (NYSE:DIS), Apple (NASDAQ:AAPL) and Comcast (NASDAQ:CMCSA) are just among the few companies creating license original content for streaming. This will help Roku Inc grow as content creators get access to millions of audience and Roku Inc active accounts makes it attractive.
Since I am looking at a relatively long-term investment horizon, the company’s international growth plans will also deliver results and stock upside. It is worth noting that the transition to streaming is a global phenomenon and Roku Inc plans to increase international investments.
According to the company’s 4Q18 letter to shareholders, these investments will start showing results beyond 2020. The key point is that Roku Inc still has headroom for growth within the United States. In addition, international markets are likely to ensure that the company’s strong growth trajectory sustains.
Conclusion On Roku Stock
As there is sustained shift to streaming, the journey for Roku Inc has just begun. The company’s growth related to Roku TVs and players remains strong even amidst competition. In addition, the company’s effort to provide active analytics to advertisers is likely to translate into higher advertising revenue.
The trend in average revenue per user has been positive for the company. The trend is likely to sustain as per household streaming (hours per day) continues to increase. While higher streaming hours does not directly translate into revenue. Higher viewer engagement also implies higher scope for monetization through advertising in the long-term.
Therefore, Roku Inc is likely to witness sustains revenue growth and that will keep the market participants excited about the stock. The cash flow growth is unlikely anytime soon, but as long as ARPU growth sustains, the overall stock trend will remain positive.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
