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Look for a Mid-Summer Turnaround for Roku Stock

Tezcan Gecgil

Despite the weakness in the broader markets in May, not all stocks have suffered the same fate. One stock that has been a bright spot is Roku (NASDAQ:ROKU), the largest over-the-top streaming content provider. On May 21, ROKU stock hit an all-time high at $87.65.

Roku Stock Is A Long-Term Winner That's Due For Some Short-Term Turbulence

Source: Shutterstock

U.S. consumers are moving from traditional pay TV services to streaming delivery services. And advertisers are following viewers. Therefore I would not bet against Roku shares longer-term.

However, there is likely to be some profit-taking in the stock in the next few weeks. Such a decline would potentially offer investors better entry points if they decide to hit the buy button later in the year. With all of that in mind, let’s look at what may be next for Roku stock.

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Where Is ROKU Stock Now?

The streaming device platform Roku, which also is the leading connected TV manufacturer in the U.S., became a darling of Wall Street soon after its IPO in 2017. The price of Roku initially went up from an opening price of $15.78 to a high of $77 in just over a year, benefiting from the disruptive internet entertainment revolution that has made viewing more personalized.

Then came the selloff in the last quarter of 2018 — especially in the tech sector — which was seen as an important signal that investors were no longer willing to be exuberant with technology stocks and their rich valuation numbers. On Dec. 24, Roku saw a 52-week low of $26.30.

As Roku released two consecutive strong earnings reports first on Feb. 22 and  later on May 8,  bullish momentum came back into the stock and the stock kept rewarding the shareholders. Especially after the Q1 earnings released in May, Roku stock soared the next morning as well as the following several trading days. Year-to-date, ROKU stock is up over an eye-popping 170%.

Roku’s Business Model is Evolving

Roku stock’s revenue can be divided into two segments. “Player” which represents sales of its digital media boxes, and “Platform” which includes advertising sales, licensing and other non-hardware revenue sources.

In its earlier years, Roku’s player segment accounted for about 75%, while its platform segment, which generates revenue mainly through advertising and content partnerships, provided the other 25%.

However, these ratios have been changing rapidly. Now the platform segment accounts for the bulk of the company’s sales. And Roku’s device sales growth is decelerating. The expanding platform business, in return, means that the advertising business is growing.

At present, Roku and Hulu, a video streaming service that is majority-owned by Disney (NYSE:DIS), are the market leaders in over-the-top (OTT) advertising. OTT ads are shown on a TV screen through a smart (connected) TV, or streaming device.

For example, Roku sells display ads that it shows on its home screen and on its screen saver. The company also offers ads within the videos it streams from particular channels available through the player.

ROKU’s Impressive Growth

According to the earnings result of Feb. 22, in Q4 2018, ROKU’s platform revenue, which made up about 45% of total revenue, grew 129% year-over-year (YoY).

Then came the earnings release of May 8 which showed a 79% YoY increase in platform revenue to $134.2 million. Now, platform revenue accounts for 65% of total revenue. Roku’s accelerating growth has led to a 51% YoY growth in total revenue, which reached $207 million.

ROKU stock also reported strong Q1 sales for both Roku TVs and players. More than one in three smart TVs sold in the U.S are Roku TVs. It has indeed taken the lead from Samsung to become the number one selling Smart TV operating system (OS). Roku’s OS, which is built specifically for televisions, is also available in Roku streaming boxes.

The operating system enables Roku to have a direct relationship with its almost 30 million subscribers, who are increasingly spending more time on the platform.

In its quarterly results, ROKU provides guidance on revenue, gross profit, net income, and adjusted EBITDA. In its Q1 2019 earnings, the group impressed investors with guidance on all four metrics that came above expectations for the rest of the year.

Adoption of OTT video services will likely increase in double digits both in the U.S and overseas. And Roku management is also looking at international expansion as the next strategic area of growth.

The company aims to grow the number of countries it operates in and to add local content to attract international viewers. However, analysts believe that it will be several quarters before Roku firmly establishes relationships with international retailers and manufacturers and successfully markets its products globally.

Bulls vs. Bears amid Intensifying Competition

Roku is a growth stock, but it’s also a speculative stock. Long-term ROKU bulls happily highlight many of Roku’s competitive advantages, starting with ROKU’s first-mover advantage in OTT advertising, share of smart TVs sold in the U.S. and projected annual growth of over 30% in the rapidly expanding over-the-top streaming market.

On the opposing side of the coin are the nervous investors and short-sellers who are looking for any excuse to short ROKU stock. They believe that the market is setting itself up for disappointment. Can Roku’s future quarters indeed be as bright as investors want to believe?

Unlike Netflix (NASDAQ:NFLX), Roku does not generate content. This is another reason why some investors worry that Roku’s revenue growth through subscriptions may simply be not enough to justify the rich valuation. The company still operates at a net loss and is burning cash rather fast.

ROKU is facing increasing competition on multiple fronts from several tech and media giants. Rivals such as Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Chromecast, Apple’s (NASDAQ:AAPL) Apple TV, Amazon’s (NASDAQ:AMZN) Fire TV as well as Disney+.

Going forward, will Roku be able to not only hold but also gain ground? As these competitors continue to make their mark in the streaming platform landscape, investors may decide to take some money off the table, pressuring the recent price gains.

In March, the stock was hit with several downgrades by analysts who voiced concern at stretched valuation levels. If the broader market does not go up as rapidly as it has done over the past few months, then the momentum in high-flying stocks like ROKU would slow down, too.

If Roku cannot keep up with the aggressive growth assumptions, then shareholders may become more concerned with low profits as well as its margins and the stock price could easily suffer. In other words, could the market be getting ahead of itself?

Short-Term Technical Analysis

As a result of the impressive 2019 price gains, short-term technical indicators have become over-extended. Investors who pay attention to short-term oscillators should note that ROKU’s technical message has also become “overbought.”

Therefore, in mid-March, following the downgrades, it was not surprising to see a rapid fall of 14% in one day on the headlines.

While long-term investors would now like to see Roku go over the $90 level and reach $100, traders may push the price down and keep the range between $60 and $70, possibly until the next earnings repot in Aug. 2019.

Thus in case of a broader market decline in the coming weeks, a pullback toward the mid-$60 level might occur in ROKU stock.

The Bottom Line on ROKU Stock

ROKU stock is likely to experience volatility in May and June. So investors should not rush to hit the buy button on Roku in the coming weeks. They may want to wait for the release of the next quarterly statement later in the summer to re-evaluate the balance sheet and the fundamentals.

In recent months, ROKU stock has given investors a lot to be optimistic about and investors who buy the shares on the dips are likely to be rewarded handsomely within a few years.

In the meantime, Roku may also find itself in the middle of a bidding war from the competitors to be acquired. After all it has experienced strong growth since its IPO  and has an enviable advertising business that combines mobile with television.

As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.

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