With a market cap of $11.7 billion, Roku (NASDAQ:ROKU) stock is the largest over-the-top streaming content provider in the U.S. On June 21, ROKU stock hit an all-time high at $108.32. Year-to-date, the stock is up 238%, as U.S. consumers move from traditional pay-TV services to streaming delivery services.
Advertisers are following those viewers. That’s reason number one why, longer-term, I would not bet against Roku shares whose revenue increasingly comes from advertising. However, as the earnings season gets busy, there is likely to be some profit-taking in the stock in the next few weeks. Such a decline would potentially offer investors better entry points if they decide to hit the buy button later in the summer, especially around the time Roku stock releases earnings in mid-August. With all of that in mind, let’s look at what may be next for Roku stock in the second half of the year.
Evolving Business Model Fuels Roku Stock Price
Roku has been a pioneer in streaming video gadgets. The company’s revenue can be divided into two segments: “Player” which represents sales of its digital media boxes; and, “Platform” which includes advertising sales, licensing and other non-hardware revenue sources.
In its earlier years, Roku’s player segment accounted for about 75%, while its platform segment, which generates revenue mainly through advertising and content partnerships, provided the other 25%.
However, these ratios have been changing rapidly. Now the platform segment accounts for the bulk of the company’s sales. And Roku’s device sales growth is decelerating. The expanding platform business, in return, means that the advertising business is growing.
In other words, once Roku’s hardware makes it to viewers’ homes, then both subscription services and advertising revenue through the platform create the real growth for the stock.
At present, Roku and Hulu, the video streaming service that is majority-owned by Disney (NYSE:DIS), are the market leaders in over-the-top (OTT) advertising. OTT ads are shown on a TV screen through a smart (connected) TV, or streaming device.
For example, Roku sells display ads that it shows on its home screen and on its screen saver. The company also offers ads within the videos it streams from particular channels available through the player. Advertising is now the biggest component of Roku’s platform segment.
It would be important to mention that Disney’s new streaming service, Disney+, will launch on Nov. 12 and will include original movies and TV shows from the Magic Kingdom’s brands. The entertainment giant has recently announced that Disney+ will be streamed on the PS4 and Roku, which is likely to give Roku stock price a significant boost.
Roku’s Operating Metrics and Impressive Growth
According to Roku’s February results, Q4 2018 platform revenue — which made up about 45% of total revenue — grew 129% year-over-year (YoY).
Then came the May 8 earnings release which showed a 79% YoY increase in platform revenue to $134.2 million. Now, platform revenue accounts for 65% of total revenue. Roku’s accelerating growth has led to a 51% YoY growth in total revenue, which reached $207 million.
In Q1, the company had almost 30 million active accounts, which on average clocked more than three hours a day watching video content. Netflix (NASDAQ:NFLX) has about 60 million U.S. subscribers and they watch about two hours of programming each day. Going forward, Roku investors are possibly expecting the company to reach a similar subscriber base that watches even more hours of content.
In May, ROKU stock also reported strong Q1 sales for both Roku TVs and players. More than one in three smart TVs sold in the U.S. are Roku TVs, having taken the lead from Samsung to become the top-selling smart TV operating system (OS). Roku’s OS, built specifically for televisions, is also available in Roku streaming boxes.
The operating system enables Roku to have a direct relationship with its 30 million subscribers, who are increasingly spending more time on the platform.
In its quarterly results, ROKU provides guidance on revenue, gross profit, net income, and adjusted EBITDA. In its Q1 2019 earnings, the group impressed investors with guidance on all four metrics that came above expectations for the rest of the year.
Adoption of OTT video services will likely increase in double digits both in the U.S. and overseas. And Roku management is also looking at international expansion as the next strategic area of growth.
The company aims to grow the number of countries it operates in and to add local content to attract international viewers. However, analysts believe that it will be several quarters before Roku firmly establishes relationships with international retailers and manufacturers and successfully markets its products globally.
ROKU Stock’s Constant Bull-Bear Question
Roku is a growth stock, but it’s also a speculative one. Long-term ROKU bulls happily highlight many of Roku’s competitive advantages, starting with the platform’s first-mover advantage in OTT advertising, share of smart TVs sold in the U.S. and projected annual growth of over 30% in the rapidly expanding over-the-top streaming market.
On the other side of the coin are the nervous investors and short-sellers who are looking for any excuse to short ROKU stock. They believe that the market is setting itself up for disappointment. Can Roku’s future quarters indeed be as bright as investors want to believe?
Unlike Netflix or Disney stocks, Roku does not create content. This is another reason why some investors worry that Roku’s revenue growth through subscriptions may simply be not enough to justify the rich valuation. And what if Roku cannot add enough new subscribers or cannot monetize the user base to cover the operating expenses?
In other words, are ROKU shareholders looking at a pie to the sky? If Roku cannot repeat its blockbuster subscriber growth performance in the next quarterly results, investors may decide to punish the stock later in the year.
The company still operates at a net loss and is burning cash rather fast. In the earnings report, management highlighted that operating expenses are projected to increase. Potential investors should remember that Roku’s net loss is expected to continue at least for several quarters.
Roku is also facing increasing competition on multiple fronts from several tech and media giants. Rivals include Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Chromecast and YouTube, Apple’s (NASDAQ:AAPL) Apple TV, Amazon’s Fire TV as well as Disney+. In other words, the cord-cutting revolution is here to stay and the space ROKU operates in is fiercely competitive and saturated.
Will Roku be able to not only hold but also gain ground? As these competitors continue to make their mark in the streaming platform landscape, investors may decide to take some money off the table, pressuring the recent price gains.
Should Investors Worry About ROKU Stock’s High Valuation?
ROKU stock trades at a high valuation, especially compared to its tech peers. For example, its current price-to-sales (P/S) ratio is over 14x. Companies generate revenue from the sale of goods and services. Analysts prefer a low P/S ratio, ideally below 1x. However, a P/S number between 1x and 2x is more common. To put the metric into perspective, S&P 500 index‘s average price-to-sales ratio is 2.1x.
Another way to analyze the P/S ratio is to compare companies in similar industries or segments. Our readers may be interested to know that the P/S ratio for Amazon (NASDAQ:AMZN) is 4x. For Disney stock, the P/S ratio stands at 3.5x. And for Netflix, the P/S is about 10x.
Earlier in the year, ROKU stock was hit with several downgrades by analysts who voiced concern at stretched valuation levels. In recent weeks, we have seen even more downgrades.
If Roku cannot keep up with the aggressive growth assumptions, then shareholders may become more concerned with low profits as well as its margins and the stock price could easily suffer. In other words, could ROKU stock price be getting ahead of itself?
Also, if the broader market does not go up as rapidly as it has done over the past few months, then the momentum in high-flying shares like ROKU would slow down, too.
ROKU Stock’s Massive Price Run
ROKU stock became a Wall Street soon after its 2017 IPO. The shares went from an opening price of $15.78 to a high of $77 in a little more than 12 months, benefiting from the disruptive internet entertainment revolution that has made viewing more personalized.
Then came the market selloff in the last quarter of 2018 — especially in the tech sector — which was seen as an important signal that investors were no longer willing to be exuberant with technology stocks and their rich valuation numbers. On Christmas eve, with holiday gift-buying all but done, Roku saw a 52-week low of $26.30.
As Roku released two consecutive strong earnings reports first on Feb. 22 and later on May 8, bullish sentiment came back into the stock and the stock kept rewarding the shareholders. Especially after the Q1 earnings released in May, Roku stock soared the next morning as well as the following several trading days. And June as well as July so far have been good months for Roku shareholders. Currently, ROKU stock is around $103.
As a result of the impressive 2019 price gains, short-term momentum indicators, which describe the speed at which prices move over a given period, have now become over-extended. Investors who pay attention to short-term oscillators should note that ROKU’s technical message has also become “overbought.”
However, it is important to remember that shares can stay overbought for a long time. It is never easy to gauge when a given stock price is a peak. Only in hindsight, most investors have 20/20 vision.
While long-term investors would now like to see Roku stay over the $100 level and even reach $110, traders may push the price down and keep the range between $80 and $100, possibly until the next earnings report on Aug. 14.
Bottom Line on ROKU Stock
ROKU stock is likely to experience volatility through the balance of July and into August. So investors should not rush to hit the buy button on Roku in the coming weeks. They may want to wait for the release of the next quarterly statement later in the summer to re-evaluate the balance sheet and the fundamentals.
As long as the ROKU’s metrics are moving in the right direction, long-term investors should not pay too much attention to the daily volatility in the stock price. That said, if you already own Roku shares, you may consider hedging your position with at-the-money (ATM) covered calls with Aug. 16 expiry.
In recent months, ROKU stock has given investors a lot to be optimistic about and investors who buy the shares on the dips are likely to be rewarded handsomely within a few years.
In the meantime, Roku may also find itself in the middle of a bidding war from the competitors to be acquired. After all it has experienced strong growth since its IPO and has an enviable advertising business that combines mobile with television.
As of this writing, the author did not hold a position in any of the aforementioned securities.
