The hype buzzing around Roku (NASDAQ:ROKU) is real. In the last month alone, the streaming device maker reported blowout second quarter numbers which topped every estimate on Wall Street. That was followed by multiple analyst upgrades and huge price target hikes. And, the result has been a 20% price increase in shares of ROKU stock.
During this stretch of operational out-performance and Wall Street love, ROKU stock has soared. Year-to-date, ROKU stock is up over 425%. The S&P 500 index is up about 19% in 2019.
In the big picture, this big rally makes sense. Roku is transforming into the cable box of the streaming TV world. One day, that will be an extremely valuable position that will generate tons of high-margin over-the-top video ad and subscription-sharing revenue. In the long run, Roku has tons of potential, and ROKU stock should move higher.
But, while bullishness is warranted in the long run, caution is warranted here and now. Looking out over the next several years, it is simply tough to justify the current valuation underlying ROKU stock — even under ultra-aggressive growth assumptions — and that’s coming from a long-time bull. Evidence of said bullishness? See: My November 2018 opinion; two months later, in January; again in March; and, again in June.
Net net, ROKU stock is a long-term winner with near-term valuation risks. The best game-plan to deal with that situation? Don’t chase the rally. Let the stock cool down. Once it does, buy the dip, and hold for the long haul.
Roku Will One Day Justify Higher Price
In the big picture, Roku is a long-term winner that is transforming into the cable box of the streaming TV world, and as such, will one day produce tons of revenues and profits that will justify a materially higher ROKU stock price.
The thesis is pretty simple: Everyone is migrating to the streaming TV world. That includes a bunch of demand — consumers like you and me are spending more and more time in the streaming TV world — and a bunch of supply which is chasing that demand — by the end of 2020, every media company from Netflix (NASDAQ:NFLX) to AT&T (NYSE:T) to Disney (NYSE:DIS) will have one or more steaming services.
The dynamic of the streaming TV world is defined by increasing supply and increasing demand. In any market, whenever you have a bunch of supply and demand, someone needs to step in, organize, and connect all that supply and demand. That’s what Roku does. Through their content-neutral streaming aggregation platform, Roku allows any consumer to access their favorite streaming service in a friction-less manner, while simultaneously allowing any streaming service to reach their customers.
Sound a lot like a cable box for the streaming TV world? That’s exactly what Roku is — the streaming TV world’s cable box, aggregating and curating all the content supply in the streaming TV world so that consumers can watch all that content through one central access-point.
How does Roku make money from this? Ads and subscriptions. On one end, with millions of eyeballs in its ecosystem, Roku can populate the ecosystem with a bunch of video ad dollars that are migrating away from the linear TV channel, and looking for a home in the streaming TV channel. On the other end, Roku earns a commission for every subscription accessed through its ecosystem.
Both of those revenue streams could be quite large. Both are also high margin. As such, at scale, Roku projects as a company that could produce a ton of revenues and profits — the sum of which should warrant huge gains in ROKU stock in the long run.
Near-Term Valuation Risks Should Give Pause
Although the long-term bull thesis on ROKU stock is compelling, near-term valuation risks should give investors pause for the time being.
Here are the raw valuation numbers. (Warning: they aren’t easy to swallow.) The forward enterprise-value-to-sales multiple stands at over 17x, while the forward enterprise-value-to-EBITDA multiple is near 500x. The trailing price-to-sales multiple is over 20x. Further, Roku doesn’t project to be profitable until FY21, and in that year, earnings are projected to be about 50 cents a share … so ROKU stock is trading at 340x earnings that are two years out.
To be sure, I’m not a huge believer in looking at current and trailing valuation multiples for growth stocks. They don’t tell the whole story. As readers of my writing know, I like to make my own projections and see how that lines up with the current valuation.
But, even when I do that with ROKU stock, I still have a tough time wrapping my arms around the current price tag.
Here’s roughly what Roku did last quarter: 39% account growth, 25% ARPU growth, 60% revenue growth, and 4% EBITDA margins on a last 12-months basis. Accounts, ARPU, and revenue growth are all waning, and project to keep slowing based on Wall Street estimates. Meanwhile, EBITDA margins are projected to keep moving higher.
Here are my assumptions for Roku into 2025: 25% annualized account growth, over 10% annualized ARPU growth, over 30% annualized revenue growth, and EBITDA margin expansion to more than 25%. In other words, while I think the Roku growth narrative slows from here, I don’t think it will slow much, and I think this company will remain a big time grower for a lot longer.
But, even under those assumptions, a $170 price tag for Roku stock seems aggressive today. My 2025 EPS target for Roku is $7.50 in a best-case scenario. Based on an application software average 35x forward multiple and 10% discount rate, that equates to a 2019 price target of about $160 — below today’s price tag.
Bottom Line on ROKU Stock
ROKU stock is a long-term winner. But, investors would be foolish to ignore near-term valuation risks, as such risks may ultimately put a cap on near-term upside in the stock.
To be sure, this stock will go higher in the long run. I can’t fault anyone for treating ROKU stock as a buy-and-hold situation. But, for investors looking to commit new money into the stock, there are probably better entry points than at the currently extended $160-$170 price range.
As of this writing, Luke Lango was long NFLX and T.
