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Should Roku Stock Be Part of Your Portfolio?

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Roku (ROKU) stock has generated exceptional returns this year. The stock has risen 241.0% since the beginning of 2019. Roku shares fell 38.0% in 2018. The stock lost more than half of its value in the last quarter of 2018. Roku has regained lost ground and more this year. Currently, Roku stock is trading at $104.54, which is 3.5% below its 52-week high.

Roku shares have been volatile in the last few days after the downgrade by RBC analyst Mark Mahaney. He downgraded Roku to “sector perform” from “outperform” last week. Mahaney said, “Given what we view as sustainably robust growth and profitability levels, we believe ROKU’s YTD outperformance is fully justified. However, with the stock now trading at an intrinsically robust multiple [of 11 times its price to sales ratio], we see risk-reward as less compelling. Hence the downgrade.”

RBC maintained a 12-month target price of $90.0 for Roku stock. The rapid rise in Roku’s stock prices will likely concern investors and analysts. The stock is trading at premium valuations and at 11.0x its 2019 sales. However, strong growth estimates support lofty valuations.

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What drove the stock?

Roku is a streaming platform. The company will likely benefit from the cord-cutting phenomenon. Roku’s Platform segment consists of fees from advertisers and content publishers. The segment also contains fees from licensing the technology and proprietary operating system. The Player segment’s sales consist of revenues from streaming media players and accessories through retailers and distributors.

Roku’s Platform business saw its revenues grow at a compound annual growth rate of 102.0% from $320 million in 2015 to $740 million in 2018. The Platform segment accounted for 15.0% of the total sales in 2015. The number rose 55.0% by the end of 2018. In the first quarter, Roku’s Platform segment revenues rose 79.0% year-over-year to $134.2 million. The segment’s sales accounted for 65.0% of the sales.

In the first quarter, Roku’s sales rose 51.0% YoY—up from the 46.0% growth experienced in the fourth quarter of 2018. The company’s management remains optimistic about the growth in 2019. The company expects its sales to rise 40.0% YoY to $1.04 billion.

Solid long-term growth potential

Roku is a leader in the US market. The company said that its operating system technology was part of 33.0% of smart TV sales in the US. Google licensed out its Android technology. As a result, Google is dominating the smartphone segment. While Roku is a major player in domestic markets, it’s just starting to target international expansion.

Currently, the US market accounts for over 90.0% of Roku’s sales. The company has a great opportunity to expand internationally. Roku stock will gain exponentially—like Netflix.

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Key growth metrics

The key driver for Roku’s Platform business is the number of active accounts and ARPU (average revenue per user). Roku’s active accounts have risen 40% YoY from 20.8 million to 29.1 million. The streaming hours have risen 74% from 5.1 billion to 8.9 billion.

The ARPU has also increased due to user engagement. The company’s ARPU rose from $15.07 in the first quarter of 2018 to $19.06 in the first quarter. The metrics will improve going forward. Roku’s letter to shareholders stated that cable and satellite TV companies in the US lost 3 million subscribers last year. The company lost 1 million subscribers in the first quarter. The linear TV viewing hours among 18 to 34-year-olds have fallen 50.0% since the beginning of 2010.

Roku’s channel offers over 10,000 free ad-supported movies and TV episodes. The channel also offers 25 live streaming channels. The channel offers ad-supported content, live programming, and premium subscriptions. Roku thinks that the subscription-based and ad-supported business models will co-exist and drive sales growth in the future.

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What’s the verdict on Roku stock?

Investors will likely be cautious when a stock triples in six months. However, Roku’s growth story is solid. Analysts expect Roku’s revenues to rise 41.2% to $1.05 billion in 2019, 34.2% to $1.41 billion in 2020, and 29.5% to $1.82 billion in 2021. While the company is still posting a non-GAAP (generally accepted accounting principles) loss, its earnings are estimated to expand at a strong pace from 2020.

The next key driver for Roku stock will be the upcoming earnings. The stock is very volatile. Roku stock will continue to be volatile over the next few years. If Roku beats analysts’ earnings estimates, the stock will continue to move higher. If Roku misses analysts’ estimates, the stock will lose market value. A decline in Roku’s stock price will help investors purchase shares at an attractive valuation.

What do analysts think? The 19 analysts tracking Roku provided a 12-month average target price of $83.63. The target price indicates that Roku is trading at a premium of 20.0% to the average estimates.

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