Roku (NASDAQ:ROKU) stock has become one of the best-performing tech stocks in recent years, and 2019 was a particularly good year for ROKU stock.
Following on the streaming success of Netflix (NASDAQ:NFLX), Roku built the device that helped bring streaming to television sets. However, more than that, they created an ad-based ecosystem that looks set to dominate the streaming industry.
As a result, Roku stock has seen massive growth since its 2017 high. Still, the stock has grown far beyond its valuation and now must depend on charts, speculation, and momentum for further growth.
The company looks set to lead the streaming industry, and longer-term ROKU should trade at higher levels. However, at current prices, it appears more likely to struggle in the short- and medium-term.
ROKU Shows Resiliency Amid Struggle
Recently, I described ROKU as “too dangerous to touch” before it announced earnings. I was right at first as it plunged by 16% after the third-quarter earnings announcement. However, within one week, it had recovered its losses.
It traded higher than the pre-earnings price until it fell by more than 15% on December 2nd. This time, the issuance of an additional one million shares caused the decline. Still, despite the bad news, the current ROKU stock price of around $146 per share exceeds the levels where it traded just before earnings.
Despite my pessimism, I do not question the long-term bull thesis on ROKU. They have wisely made the pivot from an equipment provider to the creator of the dominant streaming ecosystem. It has managed to maintain its market share despite competing against tech heavyweights such as Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG), Amazon (NASDAQ:AMZN), and Microsoft (NASDAQ:MSFT).
Roku Funds Itself Through Dilution
Moreover, while it hurts stockholders short term, I think employing the dilution strategy at this elevated stock price is a wise strategy.
At the current price, such a share sale would raise around $146 million. This could cover losses at current rates for about three years. By that time, the company might become profitable.
I think even stockholders will eventually forgive the company if it meets or exceeds its long-term potential. Analysts project losses beyond 2021, and ROKU sells at more than 21 times sales, even after the announcement. I think this funding strategy causes the least harm to the balance sheet, and it seems to have done little to hurt investor appetite for the shares.
Roku Faces Short, Medium-Term Struggles
Still, for now, I see limited short or medium-term upside in ROKU. At the current price-to-sales (PS) ratio, we have little more than momentum to evaluate this company in the shorter term. In September, it began its pullback after approaching the $170 per share level. In late November, it pulled back from almost the $165 per share level. This indicates that a double-top may have formed.
If this double-top has occurred, we have a 10-15% upside before the Roku stock price returns to that point. Should sentiment turn negative, ROKU would have to lose more than half of its value to return to a single-digit PS ratio.
Chris Tyler seems to agree. He sees indications in the charts that could mean a retest of the $80-$85 per share price level. The resiliency after earnings and after announcing the dilution indicates this downside may not happen. However, with little potential upside, I do not see any reason to buy at this time.
Final Thoughts on Roku Stock
Although ROKU will likely move higher long term, both valuation and charts indicate more downside in the short- and medium-term. Roku is the relatively small company that has successfully staved off competition from the most formidable competitors in tech. That by itself makes it a great investment at the right price.
However, after falling back from above $165 price level, it may have finished rising for the foreseeable future. At 21 times sales, bad news could hurt the stock more than good news would help it.
As the world continues to embrace streaming more fully, Roku will turn profitable, and at some point, move higher. But investors can probably find a better entry point than the current $146 per share.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
