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Why the Outlook of Roku Stock Is Mixed

Chris Lau

As markets get rocked due to the trade war between the U.S. and China, technology stocks are falling. The Nasdaq (NASDAQ: QQQ) fell 3.6% in the last week and 6% in the last month. In this investing climate, momentum and growth investors may want to look at stocks bucking the trend. Roku, Inc. (NASDAQ: ROKU) is a good candidate. Roku stock price closed Friday at $89.98, a new 52-week closing high.

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

Source: Shutterstock

Roku’s 80 Million Share Offering

ROKU is selling 1 million shares of Roku stock. The company has a float of 81 million shares, which suggests the dilution caused by the sale of shares is minimal. With Roku stock price up so sharply this year, the roughly $90 million of gross cash (excluding fees owed to the company’s underwriter) raised by the sale of Roku stock will give the company more firepower to pursue growth. Roku’s timing is the key success factor in this transaction. It is exploiting  the high Roku stock price to generate a large amount of money per share.

Savvy owners of Roku stock could sell into the rally, betting that the sale of shares will eventually send Roku stock price lower. Bears, who are shorting 11.6% of the shares of ROKU, are suffering for now. And Roku could use its cash to invest in operations, helping it to becomes the next technology-media giant.

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Comparing ROKU and NFLX

Netflix (NASDAQ: NFLX) is in the same sector as Roku.  NFLX is valued at nine times its sales and 27 times its book value. Surprisingly, ROKU is valued at 12 times its sales and 27.6 times its book value, yet Netflix has no debt. Still, as a fast-growing firm with an unlevered balance sheet, ROKU may have lots of room for growth.

Positive Momentum in Business

In its first quarter, Roku’s revenue rose 51%, while its gross margin increased 2.6 percentage points year-over-year to nearly 49%. It ended the quarter with $290 million in cash and equivalents. So in the wake of the sale of Roku stock, ROKU has up to $380 million of cash available to invest in its business.

On May 22, Roku introduced a new analytics tool for internet video  advertisers. The company clearly understands the fundamental shift of many Americans from TV to internet is permanent.

ROKU cited Baskin Robbins and RE/MAX as two of its advertising customers that will benefit from a higher ROI as a result of advertising with ROKU.

Growth Opportunity

As long as TV manufacturers keep utilizing Roku’s ecosystem in smart TVs, Roku’s user base will keep growing. As more viewers join the connected world through ROKU, the company’s ad sales should continue to rise. Increased sales of Roku’s devices, combined with higher demand for its ads, will lead to continued strong revenue growth.

Valuation and the Bottom Line on Roku Stock

Seven analysts covering Roku stock have an average price target of $76, according to Tipranks. The lowest price target on ROKU,  which calls for a 16% drop in Roku stock price, is consistent with valuation models that assume its annual revenue growth will slow to 18% – 33% over the next five years.

Roku stock is at risk of profit-taking pressures this week. Though ROKU’s prospects are bright, driven by strong advertising revenue and growing viewership, near-term volatility may hurt ROKU stock price. Yet even if the selling pressures don’t materialize, Roku stock price won’t keep advancing unless the company reports strong Q2 results in a few months.

Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.

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