For the better part of the past year, I’ve been ringing the bull horn on shares of streaming player maker Roku (NASDAQ:ROKU). My bull thesis on Roku stock was simple. ROKU is in the early stages of transforming into the cable box of the streaming TV world. It will naturally benefit from huge user, revenue and profit growth as non-smart TV users and ad dollars shift in bulk to the streaming channel over the next several years.
That was the right call to make. In the past year, Roku stock is up 270%.
It’s easy to recommend sticking with the rally of ROKU. Given its low-priced media players and strong competitive positioning in the smart TV market, ROKU will sell a ton of devices this holiday season. At the same time, the introduction of Disney+ into the streaming ecosystem will likely provide a nice holiday boost to Roku’s engagement numbers.
Amid all these positive developments, ad dollars will more aggressively flow from conventional TV to streaming ecosystems, and Roku’s ad revenues should continue to roar higher.
In other words, it looks like ROKU is set for a monster holiday season, so investors should stick with the rally of ROKU stock, right?
Yes and no. While I do think ROKU stock price can power higher into the end of the year, I also think that worries about the stock’s valuation could short-circuit this rally. That is, even using aggressive growth assumptions, I think ROKU stock is worth anywhere between $150 and $160 today. That’s exactly where the shares trade today.
Thus, the ability of Roku stock to climb further based on fundamentals is limited. That doesn’t mean ROKU stock won’t rise in the near-term. It just means investors should proceed with caution at these levels.
ROKU Will Be a Winner in the Long-Term
Everyone is pivoting from conventional TV to streaming TV thanks to streaming’s pricing and convenience advantages. This pivot includes both consumers and content creators. Thus, over time, the streaming TV landscape will look a lot like the conventional TV landscape.
There will be a ton of streaming services, which will basically be like the “channels” of the streaming TV world, and a ton of consumers who subscribe to all those streaming services. Roku provides the very necessary service of giving unparalleled, wide distribution to all those streaming services, and connecting all those consumers to their favorite streaming services.
In this sense, ROKU is turning into the cable box of the streaming TV world. Although many companies could carry out that function, size matters, since consumers like consistency and content providers want wide reach. Thus, the bigger Roku gets, the more content providers need to distribute their streaming services through Roku. The more that happens, the more consumers will trust Roku ‘s ecosystem to provide everything they need.
In the long-run, both content providers and consumers will continue to flock to Roku’s ecosystem, so as the streaming TV space grows, Roku will get bigger, too.
According to Magna Global, streaming only accounts for 29% of U.S. TV viewing. That share will move up to 100% over time. Perhaps even more mouth-watering for investors, the streaming channel has only captured 3% of TV ad budgets, meaning that Roku’s ad business truly is in the first inning of a huge, long-term growth spurt.
Given these fundamentals, the users, revenue, and profits of ROKU are well-positioned to keep growing at a robust rate for the foreseeable future. As long as the company keeps growing rapidly, ROKU stock price will power higher in the long run.
The Shares Seem Fully Valued
Although ROKU stock is poised to be a long-term winner, the shares do seem fully valued now, and worries about its valuation may limit further near-term gains by Roku stock price.
An in-depth look at my numbers can be found here. Long story short, thanks to the aforementioned non-cyclical tailwinds, Roku should sustain 20%-plus account growth and 30%-plus revenue growth for the next few years. At the same time, its profit margins should march materially higher as its ad business, which has high gross margins, grows and as sustained high revenue growth increases its profitability.
Assuming all those positive catalysts, my best guess at its earnings per share potential by 2025 is $7-$7.50. Based on a forward price-earnings multiple of 35, which is average for application software companies and a 10% discount rate, that equates to a 2019 price target of somewhere between $150 and $160.
That’s where the shares are trading hands today.
Roku stock does have plenty of positive catalysts on the horizon. ROKU will have a strong holiday season, supported by high ad revenue growth spurred by the sale of low-priced media players and the shift of ad dollars to streaming channels and high engagement growth due to the launch of Disney+.
Those catalysts may be enough to offset near-term valuation worries. Then again, they may not be. As a result, investors should proceed with caution at these levels.
The Bottom Line on ROKU Stock
Over the long haul, I love ROKU stock. But in the near-term, I’m worried that positive holiday catalysts won’t be enough to offset its high valuation. Perhaps ROKU stock will head higher over the next few months. But I think it’s more likely that the shares will struggle to advance, eventually pulling back below $150.
If or when that happens, be ready to buy ROKU.
As of this writing, Luke Lango was long ROKU.
