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Is Roku Stock a Buy Prior to Quarterly Earnings?

ROKU stock's upcoming results will give investors a chance to analyze whether it can sustain growth

Buying a stock during earnings season can be unpredictable and somewhat tricky for the average investor. The largest domestic streaming-TV platform Roku (NASDAQ:ROKU) is expected to release earnings on Nov. 6. As consumers have been moving from traditional pay-TV services to streaming services, ROKU stock has become a clear winner. On Sept. 9, Roku shares hit an all-time high at $175.66. And year-to-date, the stock is up over an eye-popping 342%.

Is Roku Stock a Buy Prior to Quarterly Earnings?
Source: Michael Vi / Shutterstock.com

However, between Sept. 9 and Sept. 30, Roku stock fell over 40% and hit a low of $98.08. Then October saw the shares go back up to $139.59. Now, Roku stock is hovering around $130.

I would not bet against Roku shares longer-term as management is successfully increasing the customer base. Yet I’m willing to wait for the release of earnings before buying into the stock. Here is why.

Streaming TV Wars and Roku Stock

In 2007, Netflix (NASDAQ:NFLX) became the first company to stream video online, marking the start of a series of disruptions in the TV industry. A decade plus on, investors are now beginning to wonder if the streaming video market has become rather crowded. Roku has been a pioneer in streaming video gadgets. The company started as a hardware manufacturer, in its early days building boxes to enable viewers to watch streaming content on their TVs.

Therefore it has had the first mover’s advantage in the streaming device market. At present, Roku and Amazon (NASDAQ:AMZN) control about 70% of the U.S. streaming device market. Roku is ahead of Amazon domestically; however the latter has made considerable headway globally, where Roku is still lagging. Europe seems to be the next phase of international growth for both companies.

In addition to Amazon’s Fire TV, ROKU is facing increasing competition from tech rivals such as Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Chromecast and Apple’s (NASDAQ:AAPL) Apple TV. Indeed, the September decline in Roku stock price was exacerbated when Comcast (NASDAQ:CMCSA) said it was going to give away free streaming boxes — Xfinity Flex — to internet subscribers.

Comcast customers will be able to access streaming services and manage other connected devices through their televisions. Thus Roku may likely be adversely affected as some users may decide to use Comcast’s free streaming box.

Meanwhile, as the streaming wars heat up, could ROKU stock may become a takeover candidate?

How ROKU Stock Makes Money

Currently, ROKU stock’s revenue is fueled by two segments: Player, which represents sales of its digital media boxes; and, Platform, which includes advertising sales, licensing and other non-hardware revenue sources.

Initially, 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. The platform segment accounts for the bulk of the company’s sales. Management monetizes the platform by offering subscription-based as well as ad-supported streaming services for viewers.

Roku takes a share of subscriptions and ads from third-party streaming services that are available on its platform. The expanding platform business means that the advertising business is growing. As management changed Roku’s business model, the share price has been rocketing up.

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. The way Roku delivers personalized ads to TV audiences can in some ways be compared to the way Facebook (NASDAQ:FB) delivers ads over social media.

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.

Investors Cheered Roku’s Q2 Results

According to the financial results released on Aug. 7, ROKU’s revenue increased 59% to hit $250.1 million. Platform revenue was up 86% YoY, topping $167 million. This segment now makes up more than two-thirds of total revenue.

Roku’s active accounts figure jumped to 30.5 million, each of which, on average, watch more than three hours of video content every day. On the other hand, 60 million Netflix U.S. subscribers watch about two hours of programming each day.

Both have room to grow, according to a recent study which showed overall, U.S. adults watch about six hours of content daily. In Q3 results, Roku investors will pay attention to whether the company has reached a higher subscriber base that watches even more hours of content.

ROKU stock also benefited from strong Q2 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 August, Roku management also announced that the company was working with Walmart  (NYSE:WMT) to roll out branded hardware. They will be sold under Walmart’s “ONN” private-label brand. At present, over 40 million U.S. households own a Roku device.

Finally, adoption of over-the-top (OTT) video services will likely see double-digit increases both in the U.S. and overseas. And Roku management is also looking at international expansion as the next strategic area of growth.

Could Roku’s High Valuation Derail the Stock?

Roku is a growth stock as investors assume that management will be able to increasingly monetize the growth in user numbers. Thus if ROKU stock cannot keep up with the aggressive growth assumptions, then skeptics may become more concerned with low profits as well as its margins, and the stock price could easily suffer.

Most ROKU shareholders are well aware that the stock does not trade at bargain-bin valuation ratios, especially compared to its tech peers. For example, its current price-to-sales (P/S) ratio is over 16.2x. Companies generate revenue from the sale of goods and services. Analysts prefer a low P/S multiple, ideally below 1x. However, a P/S number between 1x and 2x is more common. To put the metric into perspective, S&P 500‘s average price-to-sales ratio is 2.1x.

Investors can also analyze the P/S ratio by comparing companies in similar industries or segments. Readers may be interested to know that the P/S ratio for Amazon is 3.5x. For Disney stock, the P/S ratio stands at 3.2x. And for Netflix, the P/S is about 6.5x.

Earlier in the year, ROKU stock was hit with several downgrades by analysts who voiced concern at stretched valuation levels.

Should Investors Buy Roku Stock Now?

The streaming-TV industry has become a competitive marketplace with rapidly realigning powers and players. And Roku stock has been one of this year’s hottest investments. However, the meteoric rise of the ROKU stock price has recently stalled.

If you are an investor who also pays attention to technical analysis, short-term indicators are pointing to more volatility ahead. As a result of the impressive 2019 price gains, longer-term momentum indicators, which describe the speed at which prices move over a given period, have now become over-extended. Yet due of the choppiness since September, it is hard to see a clear trend established, especially prior to the earnings release in a few weeks.

Therefore, investors should not rush to hit the buy button on ROKU stock during the rest of the month or in the first days of November. If Roku management releases a positive earnings surprise, then the shares could go up higher.

As long as ROKU stock’s fundamental 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 Nov. 15 expiry. Such a hedge would enable investors to participate in a potential increase in the stock price and also offer some downside protection in case the stock price falls in the coming weeks.

As of this writing, the author did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2019/10/is-roku-stock-a-buy-prior-to-quarterly-earnings/.

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