The problem with delivering a 337% annual return, as Roku (NASDAQ:ROKU) did in 2019, is that you ratchet up investor expectations. Naturally, those expectations have been broken so far in 2020, with Roku stock down 18.9% year to date through March 3.
Roku was my candidate for the stock of the year in 2019. So far, in 2020, not so much, but it’s still early.
I’ve written about Roku twice in 2020. The first was in January when I said Roku was a screaming buy under $100. The second time was at the end of February when I picked it as one of seven stocks to buy that fell more than 10% over the past five days of trading. At the time, it was trading around $112. As I write this, it’s about $108, just eight dollars from moving to a double-digit stock price.
InvestorPlace contributor Vince Martin recently highlighted that Roku stock has strong support around the $100 level. Furthermore, with the current coronavirus scare likely to keep many people indoors, Roku could benefit from the outbreak.
He seems to suggest that Roku is probably rangebound at the moment with little upside or downside potential. I’m inclined to agree.
Although Roku did report solid Q4 2019 earnings February 13, the stock’s valuation of 11 times sales is significantly higher than the S&P 500 (2.3 times sales as of February 28), which means if you do buy its stock, do not expect it to skyrocket like it did last year.
That said, I do think someone willing to hold for 3-5 years isn’t overpaying around $100. Here’s why.
Roku delivered a loss of $15.7 million, or 13 cents on a GAAP basis, in the fourth quarter. If you exclude stock-based compensation, it had an adjusted profit of $10.3 million (or 9 cents a share). For the entire 2019, if you do the same, it had an adjusted profit of $25.2 million (or 22 cents a share).
However, both the Q4 and full-year numbers were down from last year. At this point in Roku’s development, I don’t think it’s worth worrying about. It’s still scaling up its business: It increased its operating expenses in 2019 by 62.2% while operating expenses were 49.6% of sales ($1.13 billion) compared to 46.5% in 2018 ($742.5 million).
I think it’s safe to assume that R&D, sales and marketing, and general and administrative operating expenses as a percentage of revenue will continue to rise until it scales its advertising platform to the point where it doesn’t need to spend as heavily on sales and marketing.
“The company posted better-than-expected financials and engagement numbers, but its forecast was mixed. Roku’s management gave an upbeat view of revenue for the quarter and year ahead but indicated that spending efforts would continue to weigh on the bottom line, prompting a disappointing earnings forecast,” MarketWatch reported in February.
In 2020, Roku expects revenues of $1.6 billion, a year-over-year growth rate of 42%. Of those sales, it will spend approximately 56.6% on operating expenses, up 700 basis points from 2019—a significant portion due to increasing its headcount to keep up with the pace of growth.
Wedbush analyst Michael Pachter lamented its inability to make money despite the 42% increase in sales in 2020.
“While we agree that the company must invest to support its next leg of growth, we fail to see how it cannot at least reach modest profitability with revenue at or above $1.5 billion,” he wrote in a note to clients in February.
Despite the analyst’s negative view on the company’s outlook for 2020, he still raised Roku’s target price by five dollars to $115. The 18 analysts (13 buys, 2 holds, 3 sells) covering its stock have an average target price of $151.72, significantly higher than where it’s currently trading.
The pathway to profitability might not be fast enough for the analyst’s liking, but it’s coming.
The Bottom Line on Roku Stock
As I said in my February article about Roku, I believe CEO Anthony Wood is one of the better chief executives in America.
“As long as the company continues to grow its active accounts, streaming hours and average revenue per user (ARPU) on a sequential basis, adjusted EBITDA will eventually arrive,” I wrote.
“In the meantime, watch for ROKU to drop below $100. If it does, back up the truck and buy like crazy. Under triple digits, it’s a screaming buy.”
Coronavirus or not, I don’t see anything that’s changed my mind about Roku’s stock. It’s a long-term buy and under $100, it’s a no-brainer.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.