There is an old saying on Wall Street that new highs are typically followed by more new highs.
Roku Inc. NASDAQ: ROKU smashed through its “old” 52-week intraday high of $108.32 set on June 20, 2019. Investors bid the stock higher by $7.60 on a day the major indexes were universally red. The breakout to $111.94 was packaged with a volume of 21.1 million shares- the heaviest day of activity in more than a month.
Typically, an upward price spike accompanied by a volume spurt means the price is heading higher. Let’s examine ROKU’s numbers to see how high the cable alternative’s share can climb or if it’s time to take money off the table and run.
First up, the paid TV service is expected to lose money this year and next. Wall Street forecasts a loss of $0.08 for 2019 and $0.49 in 2020. While losses as far as the eye can see are a major red flag, ROKU’s recent history shows a series of upside earnings surprises. Usually they do much better than analysts’ projections.
We can’t value the company using profits if ROKU’s bottom line remains underwater.
So, we need to consider revenue as the main metric. In their most recent quarter, ROKU’s top line grew 78.6% compared to the same period a year ago. That’s eye catching. However, the price of stock has risen more than 130% in the last year. That means the stock price has outpaced sales growth, another possible red flag.
Another potential red flag is that revenue forecasts for 2019 and 2020 project a slowdown in the growth rate, down to 34.1% in 2020 with $1.41 billion in sales. Slowing sales could temper the investors’ willingness to pay a high premium for a stock with no earnings.
Currently, ROKU trades at 15.61 times their trailing twelve month’s revenue, which is a high watermark for the company and a nosebleed price. For example, competitor Netflix, Inc. NASDAQ: NFLX trades at 9.63 times revenue, which is still a rather lofty number.
The average price-to-sales (P/S) ratio for ROKU since coming public in September 2017 is 8.85. During its limited trading life, the streaming video company has traded with a P/S ratio as low as 4.57. Using 2020’s revenue forecast of $1.41 billion, ROKU is trading almost right on its average price-to-sales ratio at 8.8 times sales.
Again, that feels like a high price to pay for revenue that’s 18 months from now. A lot can happen between here and there.
On the plus side, ROKU has done a decent job of increasing its profit margins in the most recent quarterly report. Total cost of revenue dropped to 51.18 percent of sales in 2019 versus 53.8% in 2018. That may not look like much on paper, but it adds up to more than $5.39 million in savings, i.e. more operating profit.
General and administrative costs also dipped year-over-year. This column pertains to expenditures for the day-to-day operations of a company like rent, keeping the lights on, salaries… The balance sheet line item fell to 10.69% of sales this year compared to 11.4% last year, saving the company another $1.47 million during the quarter.
Meanwhile, management is ramping up the good costs, sales, and marketing, along with research and development. Over the long run, building a better product and then advertising to get new customers should be a plus. However, like 2020 revenue, the payoff is down the line.
From a technical perspective, ROKU is bordering on overvalued. The stock could continue its rise, possibly tack on another 10-12%, maybe a little more, but that would be stretching it in our view. The last time ROKU broke through a 52-week high, the price topped at after adding roughly 25%. That would put a target of $125ish for the current run. However, its relative strength (RSI) reading is at 72. Typically, selling pressure starts to build when RSI reaches 70. Think of it as a ceiling, whereas a reading of 30 is the floor.
Another concern is that the recent uptrend starting in April has been chaperoned by declining volume. That’s called divergence. Normally, a rally should be accompanied by rising volume. When selling starts, the lack of a volume foundation could result in the price falling faster than it rose. In other words, timberrrr.
In our view, those who are out of ROKU but want in might benefit from patience. Once profit taking begins, $80-$90 could come into focus rather quickly. Although new highs tend to lead to new higher highs, ROKUs short-term ride up is probably closer to the end than the start.
In case you don’t know, Roku operates a TV streaming platform. The company operates in two segments: Platform and Player. Its platform allows users to discover and access various movies and TV episodes, as well as live sports, music, news, and more. In addition, the company offers streaming media players and accessories under the Roku brand name.