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Roku Stock Will Brush Its Valuation Risks Off Sooner Than You Think

ROKU stock will push back toward its all-time highs in 2020

Shares of streaming device maker Roku (NASDAQ:ROKU) went parabolic in 2019, skyrocketing from a low of $27 per share in late 2018 to a high just shy of $180 by late 2019. The catalyst? A significant and sustained consumption shift from linear to internet TV, as streaming services from the likes of Netflix (NASDAQ:NFLX), Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) and others continued to steal share from old school TV services like cable.

Roku Stock Will Brush Its Valuation Risks Off Sooner Than You Think
Source: JHVEPhoto / Shutterstock.com

As that happened, consumers spent more time with their Roku devices, and less time with their cable boxes. Advertisers took note. They reduced ad spend in the linear TV channel, and upped ad spend in the internet TV channel by nearly 40%. Consequently, not only did Roku’s user base grow dramatically in 2019, but so did its advertising revenue. This combination of robust user and revenue growth powered ROKU stock to a near seven-fold gain at one point in 2019.

To be sure, the stock has been choppy ever since hitting that $180 high in September. Shares have done little more than bounce around in the $100 to $160 range since.

But, that’s just due to near-term valuation friction. Once that valuation friction passes — and it should in early 2020 — sustained strength in the company’s core fundamentals will continue to power ROKU stock higher.

Roku Is Positioned for a Great 2020

The fundamentals and growth trends underlying Roku imply that the company is due for another great year in 2020.

At its core, the company is simply the cable box of the internet TV world. They make little devices and smart TVs, which connect you to a centralized internet TV ecosystem from which you can watch any streaming service. Importantly, Roku is the biggest player in this market, with the largest market share among both streaming devices and smart TVs. Also of note, being big is a big advantage here, because as a streaming marketplace, Roku operates on a virtuous cycle wherein more supply (more streaming services) leads to more demand (more viewers), which leads to more supply.

Consequently, for the foreseeable future, Roku is a platform pure-play on the linear to internet TV consumption pivot.

That pivot is set to accelerate in a meaningful way in 2020. Over the next twelve months, content supply in the internet TV world will grow by leaps and bounds. Disney+ and Apple TV+ will expand as they both enter their first full year of operation. HBO Max will launch. Peacock will launch, too. All of this competition will also force incumbents like Netflix, Amazon and Alphabet to up their original content production.

The result? The volume and quality of content in the internet TV channel will increase significantly in 2020. As it does, more consumers will shift more aggressively from linear TV consumption, to internet TV consumption. This pivot will provide a tailwind for Roku’s user growth trends.

At the same time, ad dollars will follow consumption, and connected TV ad spend in 2020 will also grow dramatically, providing a strong tailwind for Roku’s revenue growth trends.

Roku Stock Will Brush Aside Valuation Friction Soon

Strong fundamental trends for the company in 2020 will push its stock higher over the next twelve months, despite ostensible valuation friction.

There’s no hiding the truth. The company’s stock is richly valued at current levels (10-times forward sales). It’s also having a tough time shaking off that rich valuation (shares haven’t made any sustainable upward progress in months).

But, ROKU stock is just taking a breather here. The valuation sprinted ahead of the fundamentals in 2019. Shares have spent the last few months consolidating, waiting for the fundamentals to catch up to the valuation. In early 2020, they will catch up, boosted by healthy internet TV adoption tailwinds. Once they do, the stock will push back towards $180.

The numbers are easy to follow. My long-term model on ROKU assumes that robust internet TV adoption tailwinds, an accelerated shift towards internet TV ad spend and inherent marketplace advantages push Roku’s active account base above 100 million accounts and revenues above $5 billion by 2025. It further assumes that sustained big revenue growth and steady increases in average revenue per user drive significantly positive operating leverage in the long run.

Under those assumptions, I think $7.50 in earnings per share is a doable target for Roku by 2025. Based on an application software sector-average 35-times forward multiple and a 10% annual discount rate, that implies a 2020 price target for ROKU stock of $180.

Bottom Line on ROKU

ROKU stock is a long-term winner worth holding in the long haul. But, as is the case with all long-term winners, the stock ran into some significant valuation friction in late 2019.

Fortunately, in early 2020, ROKU stock should shake off that valuation friction, thanks to strong underlying fundamental growth trends in the internet TV landscape. As it does, shares will rally back towards their $180 highs.

As of this writing, Luke Lango was long NFLX.

Article printed from InvestorPlace Media, https://investorplace.com/2020/01/roku-stock-will-brush-its-valuation-risks-off-sooner-than-you-think/.

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