Roku (NASDAQ:ROKU) now looks like good value, with the company returning to growth from Q2 in terms of streaming hours. Moreover, ROKU stock is near a trough price, making it a bargain opportunity.
The truth is investors are worried about Christmas and the holiday season. They are hearing and reading about global supply-chain issues. As a result, their worry is that the fourth quarter will be well below last year. After all, the company seemed to issue a profit warning of sorts. Here is what management said in the Nov. 3 shareholder letter (Page 5):
“[T]he challenges created by the global supply chain disruptions will likely continue into 2022. These headwinds may have a broad impact on the holiday season in terms of consumer confidence, product pricing and availability, and advertising spend levels.”
However, the company seemed to take all that back later in the letter. In the report, Roku estimated that Q4 sales would be 37% higher year-over-year (YOY). Its estimate of $893 million at the midpoint also leads to a gross profit of $385 million at the midpoint, or 26% higher YOY.
ROKU Stock and Q3 Earnings
Surprisingly, in Q3, Roku experienced higher growth in all three of the areas that it measures its underlying metrics. These areas are active accounts, streaming hours and average revenue per user (ARPU). During the period, the company’s accounts grew 23% YOY, streaming hours rose 21% and ARPU climbed 49%.
Previously, in Q2, Roku had growth in only two of those areas, with a sequential decrease in streaming hours. The metric had dropped from 18.3 billion hours in Q1. However, streaming hours rose from 17.4 billion in Q2 to 18 billion hours in Q3.
You can see all of these stats — plus the company’s quarterly summary financials — on the first page of the shareholder letter. This part of the release also shows that adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) hit $130.1 million during the quarter, higher than Q2’s $122.4 million.
Clearly, this company is still on a growth path. Even revenue rose 51% YOY to $680 million, 5.4% higher than Q2. However, much more importantly, Roku produced excellent free cash flow (FCF) during the quarter as well.
My calculation? Roku hit $94.6 million in Q3, based on the $225.48 million year-to-date (YTD) FCF figure at the time of the report. This also represents an FCF margin of 13.9%. We can use that to estimate the value of ROKU stock.
What Roku Is Worth
Next year, analysts forecast that Roku will have sales of $3.8 billion — $1 billion more than this year, or nearly 36% growth. If we say that FCF margins will rise to 15% (assuming the global shipping crisis abates), then Roku could make $570 million in FCF.
That could raise the value of ROKU stock quite significantly. For example, using a 1% FCF yield brings the target value to $57 billion (i.e., $570 million / .01). That is 83% over today’s market capitalization of around $31 billion. It also implies that ROKU is worth $424.28 per share, or more than 81% over the Nov. 19 close price of $234.10.
However, even if we use a 1.5% FCF yield metric, the target market value is still higher than today. That puts its market value at $38 billion (i.e., $570 million / .015). This is over 22% higher than today and implies a target price of $285.60.
So, in the long term, ROKU stock is worth somewhere between $285 and $424 per share. The average of these two points is $354.50, or 51% higher.
What to Do with ROKU Stock
It turns out that analysts tend to agree with me on ROKU stock. For example, Seeking Alpha’s survey of 25 Wall Street analysts shows an average price target of $403.36. That represents a potential upside of 72% from the N0v. 19 price of $234.10.
In addition, Tipranks reports that 22 analysts have written on ROKU stock in the last three months. Their average price target is even higher at $408.24, representing an upside of 74.4%.
So, as a rarity, my price target is actually lower than analysts. You might want to take advantage of this since I am usually more ebullient on tech stocks like ROKU. All told, the stock is a very good buy right now.
On the date of publication, Mark R. Hake did not hold any positions (either directly or indirectly) in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.