Although it doesn’t seem like it on paper, I consider Roku (NASDAQ:ROKU) a contentious investment. On one hand, Roku stock represents compelling exposure to the content-streaming revolution. But on the flipside, the cord-cutting phenomenon alone won’t send ROKU to the top.
After more than a year since its fall 2017 initial public offering, this investment has become more controversial. Early on, I considered Roku stock a speculative buying opportunity despite the obvious IPO risk. This was a time when highly-anticipated debuts, such as Blue Apron (NYSE:APRN) and Snap (NYSE:SNAP), severely disappointed.
For some perspective, Blue Apron shares are firmly in the dollar menu, while SNAP isn’t too far behind. ROKU was crazy-risky, but ultimately, that risk paid off.
In my view, the company differed from other tragic IPOs in that its underlying industry is incredibly viable. Cord-cutting has become more intensive, pressuring traditional media companies like Comcast (NASDAQ:CMCSA). Thus, despite Roku’s diminutive size, the ROKU stock price had the potential to jump on the streaming sector’s strengths.
But when shares went bonkers in November of last year, investors had to reconsider the value proposition. The argument I made at the time was this: “At $20, ROKU stock was intriguing. At $40, I’m taking my profits and running for the door.”
I had every reason to voice doubts. While Roku stock had an impressive debut, that performance also raised competitors’ eyebrows. We’re not talking about run of the mill rivals, either. Instead, they are names like Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL).
This past August, I doubled down on my overvaluation concerns. The Roku stock price, again, had made a surging run. However, I didn’t like what investors received for the added premium. And despite the October fallout, I’m still hesitant.
Roku Stock has Hidden Growth Risks
In the streaming company’s last earnings report for the second quarter 2018, its robust print skyrocketed Roku stock. Management delivered exactly what it needed to: a revenue beat, double-digit subscriber growth and increased product engagement.
At first glance, almost every fundamental factor — except for the fierce competition — favored ROKU. Wall Street anticipated revenue of $141.5 million, but it came in at nearly $157 million. Monthly active users (MAUs) grew to 22 million, up 46% against Q2 2017.
That all sounded great, but the details revealed increasingly worrying signs.
For starters, on a sequential basis, MAU growth fell to fresh lows. Since Q4 2016, active subscriber growth averages 10%. But in the last quarter, this metric fell to 5.8%, representing three consecutive quarters of declines.
More critically, revenue generated by each MAU has also moved in the wrong direction. At its peak in Q4 2016, ROKU rang up $147.3 million against 13.4 million MAUs. That translates to each active sub generating $11 in sales. However, in the most recent quarter, this user output dropped to $7.13.
So while, on a nominal basis, the user stats appear impressive, investors are increasingly paying more for the privilege. That’s not something that you want to see from a smaller company fighting against well-capitalized competition.
Further, revenue per MAU has been stuck inside a bearish trend channel since Q4 2016. Subsequent quarters produced comparatively ho-hum results until Q4 2017. That’s when the company managed $9.76 per MAU. However, the following two quarters failed to capitalize on that momentum.
By the time the Roku stock price approached $78, I believe astute investors had enough. As a growth company, ROKU had to grow. When key metrics demonstrated a slowing in demand, they headed for the door.
Can You Still Trade ROKU?
On the flipside, the Roku stock price dropped 31% since the October opener. Plus, the industry’s fundamentals haven’t changed. Streaming is the new face of personal entertainment.
I also love the product. With a one-time equipment purchase, ROKU subs enjoy access to various content, including Netflix (NASDAQ:NFLX) and Hulu. Additionally, the user experience is scalable. You decide what you want or don’t want — and pay accordingly.
But like I said earlier this year, at $40, Roku stock becomes a complicated proposition. That hasn’t changed for the better at this point. In fact, with more financials to analyze, it’s becoming apparent that the company’s growth engine has weaknesses.
Does that mean you can’t advantage the current discount? My gut feeling tells me to wait. I believe ROKU has more correcting to do before it becomes interesting again.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
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