Last November, I suggested that Roku (NASDAQ:ROKU) stock would bounce back. I stated that “investors are making a mistake dumping ROKU after its recent earnings report.”
Since then, Roku stock has roared higher, moving from the low $40s to as high as $74 recently. However, since reaching $74, bullishness towards ROKU stock has waned a bit, and ROKU stock is now trading around $60.
Tara Lachapelle of Bloomberg Opinion put it well. As she noted, the latest selloff is not a function of business performance, but rather extremely hot investor sentiment that had bid Roku stock up a tremendous amount over the past couple months.
Lachapelle wrote that: “Shares of Roku Inc. have taken a beating the last few days amid a string of analyst downgrades. But shareholders can take some comfort in knowing that this was more a function of an overheated stock price than a sudden change in the TV-streamer’s business trajectory.”
I agree with her. But that does raise a question: While Roku stock was cheap in November and expensive last month, what’s the right play on it today?
Is Roku Stock Even More Expensive Than Netflix? Bloomberg’s Lachapelle noted that, by one metric, Roku stock is even more expensive than Netflix(NASDAQ:NFLX). Based on enterprise value/EBITDA, which is a popular metric for analyzing companies that do not yet have significant accounting profits, Roku stock looks exceptionally expensive.
Roku stock is trading at an EV/EBITDA ratio of more than 500, whereas Netflix’s EV/EBITDA ratio is 47. That doesn’t make Netflix cheap; an EV/EBITDA of ten is considered normal, and Bloomberg reported that the current average EV/EBITDA ratio in the media industry is just nine.
So, based on this metric, it appears that Roku is generating relatively little income or cash flow at the moment.
Heavy Competition: Roku’s pivot from selling hardware to hosting a software and viewing ecosystem comes with some major perks. But it also carries big risks. In theory, there is a huge market for Roku’s offerings, such as its ad-supported channel, among cord cutters who want to save money.
In practice, though, there are a ton of cheap streaming-video offerings that cost far less than cable. Amazon’s (NASDAQ:AMZN) standalone TV offering is growing and pairs nicely with its Amazon Fire TV Stick, which is a direct competitor to Roku.
Microsoft’s (NASDAQ:MSFT) XBox, Sony’s (NYSE:SNE) Playstation, and Apple’s(NASDAQ:AAPL) Apple TV are other products that are used by a meaningful number of consumers to access streaming-video content. ROKU is competing in a highly profitable field, but it is up against quality rivals.
Short Sellers Have Taken Profits: One of the big catalysts for the rally of Roku stock earlier this year was an aggressive short squeeze. At one point, short sellers had shorted 40% of Roku’s float That’s a tremendous number, among the highest you’ll see for a decent-sized NASDAQ company . When so many shares of a stock are being sold short, the shares can soar relatively easily.
However, those shorting Roku stock appear to have played their hand well. As Roku stock has fallen 20% in recent weeks, the those shorting ROKU have taken profits. As a result, the short interest of Roku stock as a percentage of its float is down from 40% to 11.4% now. This indicates that most short sellers took profits without driving Roku Inc stock back up. Now, if ROKU reports good news, any short squeeze of Roku stock will be much weaker.
Based On Sales, Roku Inc Stock Is Not So Expensive: Based on any one metric, it’s easy to make young companies look expensive. Bloomberg’s assertion that Roku Inc stock is expensive due to its high EV/EBITDA ratio is a fair point. But it’s not a be-all and end-all analysis.
Take a look at Roku’s price-sales ratio. Traditionally, for fast-growing tech companies with strong prospects, a P/S ratio of ten is generally considered fair. Due to the huge swings in Roku Inc stock as of late, the P/S ratio has swung between 5 and 11. Only at the very top end of that range would Roku stock potentially look too expensive. For what it’s worth, NFLX stock’s P/S ratio is 9.9, while that of ROKU has dipped back to 8.5. Based on price-sales ratio, Roku’s valuation look reasonable and maybe even a touch cheap.
Roku Is Getting Close To Break-even: By evaluating Roku’s earnings, we can see that things are looking up for the company. Remember that Netflix and many of its peers were unprofitable or only marginally EPS positive for many years. Yet their share prices still increased as their growing revenues made up for their low profitability. The important thing, however, for tech companies is not to burn so much cash as to end up having to take on heavy debt or dilute their stocks to keep their operations rolling.
In Roku’s case, management predicts that its 2019 losses will come in around $86 million on around $1 billion of revenues. That’s a net profit margin of around negative 8.6%, which isn’t too bad, and is way better than in prior years. Additionally, based on current trends, ROKU would approach overall break-even in 2020 . It would likely be profitable in both Q1 and Q4.
The Switch From Hardware to Services Is a Plus: In my articles, I often warn investors to be skeptical of tech companies that are reliant on hardware sales. It’s hard to make consistent profits on hardware, as competition is so fierce, and prices tend to plunge once competitors copy the better parts of leading products.
As a result, Roku’s move towards services and advertising, if a bit rocky, has been well-received by Wall Street. Since the transition, many of Roku’s metrics are steadily improving, with viewership of the Roku Channel rising and average revenue per user increasing. Roku’s new business model is healthy, and its results will improve further as its viewership rises. Wall Street will give ROKU high valuations if its growth continues.
If you like Roku’s outlook, the recent dip of Roku Inc stock could make it worth buying again. Although Roku’s EV/EBITDA ratio is very high, the truth is more complicated. Based on other metrics, such as Price/Sales, it’s not hard to justify Roku’s current stock price.
Still, the company appears to be several years away from strong profitability. Analysts have gotten nervous, with four firms, including Citi and Guggenheim, downgrading the shares over the past month. And Roku will report its earnings again in May. For now, I’d keep watching Roku Inc stock from the sidelines.