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Roku Stock Could Get Slammed After Earnings

Vince Martin

Roku (NASDAQ:ROKU) is back to its old ways. The ROKU stock price plunged over 40% in a matter of weeks in September. But support held right around $100, and Roku stock subsequently bounced 50%.

Post-Earnings Reaction to Roku Stock May Well Come Down to Market Sentiment

Source: JHVEPhoto / Shutterstock.com

That puts ROKU  in an interesting position ahead of its earnings report on Wednesday afternoon. The simplistic assumption might be that Roku stock will sink after the report. After all, ROKU’s market value has increased by over $5 billion in a month. That, in turn, has to mean that investors’ expectations have increased.

But for years, growth stocks have looked expensive. Then growth companies report strong earnings, and their stocks still look expensive. Selling, let alone betting against, tech companies with good outlooks, based on valuation has been a fool’s errand.

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And so the reaction to Roku’s report might well come down to one factor: is this the same market that it’s been in recent years? Roku seems likely to post another strong quarter, and its growth no doubt will be impressive. The one risk  might be that, this time, that won’t be enough.

Why ROKU Fell So Far

It’s worth trying to understand why Roku stock plunged in September before predicting where it will go in November. To be honest, even in retrospect it’s difficult to understand the sharp pullback.

The simple narrative, one pushed by a Bank of America Merrill Lynch analyst last week, is that streaming offerings launched by Comcast (NASDAQ:CMCSA) and Facebook (NASDAQ:FB) were to blame. Those potential competitive threats spooked investors and led to the reversal of ROKU stock price.

I’m highly skeptical that new competition was much of a driver, however. As Bank of America itself noted, Comcast’s device requires users to pay a monthly modem rental fee, limiting its usefulness to cost-conscious cord cutters. Facebook has had little success so far in hardware or streaming.

Meanwhile, ROKU has racked up impressive market share, even though it’s competing against the likes of Amazon.com (NASDAQ:AMZN) and Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL). It’s hard to believe an investor would pay $150 for the shares of a company that’s competing with those giants, only to sell at a lower price because two new, less threatening, rivals entered the space.

I think ROKU had just rallied too far. Its strong Q2 earnings report may have driven a short squeeze that outran underlying demand for the shares. Whatever the cause, ROKU simply ran out of buyers.

The Parallels Between Shopify and Roku

It hardly seems like a coincidence that Shopify (NYSE:SHOP) started plunging at almost exactly the same time as ROKU. The two companies are obviously very different. But the two stocks have a lot in common (and still do). Both stocks are among the biggest gainers of 2019. Among 712 stocks with a market capitalization over $10 billion, ROKU has had the best 2019, and SHOP is fifth.

Both have attractive underlying stories. And both wound up at nosebleed valuations. As investors fled formerly “hot” sectors like SaaS (software-as-a-service) and unprofitable recent IPOs. SHOP and ROKU, with their high valuations and tremendous gains, unsurprisingly felt the pressure as well.

The Key Question

Obviously, the 50% rebound of ROKU suggests investors are back to focusing on growth over valuation. Other growth stocks have rallied recently as well, though the gains  of SHOP and enterprise SaaS plays have been much more muted.

But that rebound also got ROKU back to where it was, even if the actual ROKU stock price remains 15% below its September peaks. In other words, its valuation is questionable again. Excluding cash, ROKU trades for about 15 times analysts’ average 2019 revenue estimate. And as I noted ahead of the Q2 report, about one-third of those sales come from the company’s players, which remain unprofitable.


Obviously, the company’s outlook remains strong. But, as skeptics have asked about so many stocks recently, at what valuation is its positive outlook fully priced into the shares?

ROKU and SHOP

Again, the answer for years almost always has been that  the valuation of growth stocks can rise further. And so ROKU stock certainly could rally after its earnings.

The company’s report is likely to be strong. Roku really never has missed Street estimates since its 2017 initial public offering. (Its earnings per share were below analysts’ average outlook in its first report, but one-time effects related to the IPO were to blame.)

Streaming demand is only going to rise. Disney (NYSE:DIS), Comcast, and AT&T (NYSE:T) are launching new services — and are likely to spend ad dollars on the Roku platform to promote them. Investors are going to want to own Roku stock.

Will that be enough on Wednesday? Not everyone is convinced. Options markets are projecting significant volatility, pricing in a whopping 15% move between now and next Friday. And I’d note that SHOP stock actually fell modestly after its Q3 report on Tuesday.

That report did feature a headline EPS miss — but the reported loss, excluding certain items, was driven solely by a one-time tax issue. Shopify did what it always does: it grew faster than average Street estimates, beat its operating profit guidance  and raised its full-year outlook. It wasn’t enough to keep SHOP stock from falling.

The obvious worry is that Roku stock will react to its results like SHOP stock did to its earnings. But given ROKU’s far sharper climb into earnings, the selloff could be even more severe.

As of this writing, Vince Martin has no positions in any securities mentioned.

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