Ruku (NASDAQ:ROKU) just reported its second-quarter earnings on Aug. 4 and shareholders were let down. Not only is its growth slowing, but the company gave a lower profit outlook going forward. As a result, ROKU stock has tumbled from its recent closing peak on July 26 of $479.50 to $369.21 as of the close on Aug. 11, a 23% drop over two weeks. Investors seem to be waking up to ROKU’s slowing growth prospects and its very high valuation.
Roku reported that its revenue was $645.1 million, or 81% higher than last year. However, on a quarter over quarter basis, it was up by 12.35% from $574.2 million in Q1. That represents a compound annual growth rate of 59.3%, much lower than the YoY 81% figure.
However, the underlying growth of its main category is not decelerating as fast. For example, 82.5% of its revenue comes from what it calls “Platform” revenue, or content distribution fees as well as advertising revenue. This category grew 117% YoY but on a QoQ basis, it was up 14%. That works out to an annualized compound growth of 69%, much faster than the overall 59% run rate going forward.
So, don’t get me wrong — this does not necessarily mean that ROKU stock will actually drop much further from here. It might just tread water in a range around today’s price, which will allow its valuation to fall as growth raises its earnings figures.
Where This Leaves ROKU
For one reason, sometimes ROKU gives out a poor outlook just to outperform. For example, last quarter the company wrote on page 5 of the Q1 shareholder letter it expected Q2 adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) profits would be “$65 million at the midpoint.”
But you can see on the first page of this quarter’s shareholder letter that Adj. EBITDA was actually $122.4 million in Q2, not $65 million. In fact, this was only slightly lower than the $125.9 million EBITDA produced in Q1.
In fact, in this quarter’s shareholder letter the company said almost the same thing. In the Outlook section on page 5, they said this:
“As a result, we expect adjusted EBITDA to be $65 million at the midpoint in Q3.“
That is basically a cut and paste of the same sentence from last quarter which was purposefully too low and later came in almost 100% higher.
Nevertheless, this time, investors think it might actually happen. There is no doubt that people are now enjoying doing things other than just watching TV, including Roku streaming. For example, page 1 of the Q2 shareholder letter shows that there were just 17.4 billion streaming hours in Q2 vs. 18.3 billion in Q1 (i.e., 4.9% less viewing). If that falls further this quarter, perhaps the EBITDA will actually fall, as management forecast.
In addition, the company’s margins have been falling. This can also be seen on page 1 of the shareholder letter. Player margins (i.e., from sales of TV and other device players) actually fell to the point where margins were negative 5.9%. In addition, its Platform margins fell from 66.9% to 64.8% in Q2. So the decelerating growth rate showed up in higher costs. This adds to the fear that EBITDA will tumble.
Issues With the ROKU Stock Valuation
Despite the negative outlook from ROKU and its apparently decelerating growth, analysts have actually raised their revenue forecasts for the company.
For example, in my last article on May 24, I wrote that Seeking Alpha reported that sales will reach $2.74 billion this year and $3.75 billion next year. But now, those forecasts have risen to $2.83 billion and $3.87 billion in 2021 and 2022 respectively. This is a 3.2% hike in their forecasts. This is how the stock will actually “grow into its valuation.”
Nevertheless, there is no getting around the high ROKU stock valuation. Given that it had an Aug. 11 market capitalization of $49.15 billion, according to Yahoo! Finance (which typically has the most accurate calculation), ROKU’s price-to-sales (P/S) multiples remain bloated. The 2021 P/S ratio is 17.9 times and for 2022 it is at 13.1 times.
For example, fuboTV (NASDAQ:FUBO), another fast-growing subscription-driven TV streaming stock trades for just 7.8 times 2021 forecast revenue and 4.9 times 2022. On Aug. 10, it just reported a 138% YoY growth in subscribers and 196% YoY growth in sales. This is a different business model than ROKU but still relies on TV viewership in the end. In other words, ROKU’s P/S valuation is at least 100% too high.
What To Do With ROKU Stock
If ROKU’s growth continues to decelerate (i.e., grow at a slower rate than prior growth rates), and if its EBITDA turns down 50% as the company is implying, expect to see ROKU keep falling.
However, over time the company will grow into its high valuation as long as ROKU stock stays in a range around where it is today. The problem is this could take several years. Investors might not be willing to wait to see if that happens. So, on balance, I expect that ROKU stock could end up falling at least 20% to 30% from here. Most investors won’t wait around to see if this happens. The defensive investor will wait for a bargain entry price.
On the date of publication, Mark R. Hake did not own any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.