Falling more than 54% since July 27, is it time to buy Roku (NASDAQ:ROKU) stock? The streaming company’s massive price decline in less than two months may appear to be a prime buying opportunity. But despite this “buy the dip” appeal, ROKU stock may not be done moving lower.
Why? When it comes to company-specific factors, it still has a lot on its side. But market-related factors could apply more pressure. Although the price has fallen considerably, shares continue to trade at a premium valuation, best seen in the price-to-sales (P/S) multiple of 18.64.
If markets get volatile between now and year’s end? Growth names like this one — with its current beta of 1.72 — could experience declines outsized compared to stocks overall.
Does that mean it’ll make a full trip back to its 52-week low of $157.54 per share? It’s possible. Even at prices more than half of where it trades today, it would still trade at a premium to its larger, albeit slower-growing peer, Netflix (NASDAQ:NFLX).
With high risk growth stocks are in for a world of hurt in the coming months, what’s an investor to do? It’s best to take your time with this particular one.
ROKU Stock Underlying Business Remains Strong
As seen with its sell-off in recent weeks, investors have been concerned about Roku’s slowing user growth, and decline in existing user engagement. These negative aspects outweighed the positives, such as better-than-expected revenue and earnings numbers, when the company reported its results for the quarter ending June 30, 2021 on Aug. 4. Revenues of $645.1 million came in above sell-side consensus ($618.8 million). Earnings of 52 cents per share came in well above the Street’s estimate of 13 cents per share.
It may be valid for there to be some worries with ROKU stock when it comes to its underlying business continuing to grow at a rapid clip. But a slowdown or decline in user growth/engagement may not mean high levels of future revenue growth are off the table.
Why? The company is just getting started fully monetizing its existing business. With its pivot from streaming equipment provider to ad-supported streaming platform operator, the company is ramping up its original content offerings. Most notably, it’s purchase of a 75-show library from short-lived streaming service Quibi. With around $2 billion in its coffers, it has plenty in reserve to finance further content acquisitions. International growth is something else that could enable Roku to continue growing at above-average levels.
Put simply, there’s enough in play for it to keep on scaling up. At the very least, hit projections calling for 36% revenue growth next year. That said, its pullback may not be over. Factors outside its control could result in it making another big slide lower.
Why Market-Related Factors May Sink it Lower
ROKU stock may be cheaper now than it was at the end of July, but that doesn’t mean it’s become a “cheap stock,” by any means. The company’s growth potential remains more-than-reflected, as seen from its high price-to-earnings (P/E) multiple of 188.2x and a forward P/E of 197.6x.
Further, at today’s prices, shares sell for 11.1x next year’s projected revenue, and 204.4x next year’s projected earnings. Given its still in high-growth mode, for now a rich valuation like this is sustainable. Yet if the conditions enabling it change? Look out below.
Many factors point to rocky times ahead for stocks this fall. The U.S. Federal Reserve’s planned tightening of monetary policy, along with a rise in bond yields (even as the Fed takes its time raising interest rates) could result in the stocks starting to move in the wrong direction. Worse yet, growth stocks like Roku, that have benefited most from the current near-zero interest rate environment could get hit the hardest.
To what extent? Again, as mentioned above, the stock could make another 50%+ move lower, and still trade at a premium to peers like Netflix. That of course isn’t to say it will happen. We may only end up seeing moderate levels of multiple compression. That is, valuations remain high compared to historic levels, but lower than before. Nevertheless, as this market-related risk hangs over it, waiting for what’s looming over the stock market today to play out appears to be the wisest move.
Sit On Sidelines for Now
Roku still appears to be a solid growth story. High levels of growth may still lie ahead. Between its big move into original content and its potential to expand its presence overseas, those who are bullish on it aren’t wrong to believe it could eventually scale up into a business many times the size of current options.
What’s wrong with ROKU stock? The price isn’t right. As the risk that market changes will put pressure on its valuation looms, your best move is to hold off buying it right now.
On the date of publication, Thomas Niel did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Thomas Niel, contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.