Roku (NASDAQ:ROKU) seemingly can do no wrong in investors' eyes. The ROKU stock price has risen 232% so far this year. Among stocks with a market capitalization above $1 billion, only one - Enphase Energy (NASDAQ:ENPH) - has done better.
Much of the gains seem to have come from sentiment, rather than performance. Roku's first-quarter earnings were impressive, but the company only raised full-year revenue guidance by a couple of million dollars. The increase in the ROKU stock price from pre-earnings levels has added some $4 billion in market value.
From here, it looks like too much - though, admittedly, I've said that before. Back in September, I argued investors should take profits at $70. From a short-term standpoint, that was brilliant advice: ROKU shares would drop 60% in a little over three months. Of course, the stock now is almost 50% above those levels after the torrid gains of late.
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To be sure, I don't think Roku is headed back to $35 or anything close. This remains a wonderful business. I've compared the company to Amazon.com (NASDAQ:AMZN) in terms of its potential to expand well beyond its initial model (book-selling for Amazon, player revenues for Roku). I'm more skeptical than most that Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) or Apple (NASDAQ:AAPL) will dislodge Roku from its leadership in streaming. And I see real growth ahead for Roku.
But that's kind of the point: As highly as I think of Roku as a business, I still question ROKU as a stock. And I don't believe, at these prices, it will take much for the market to come around to that viewpoint.
ROKU Valuation and Player Revenue
Roku isn't yet profitable - though it is guiding for $10-$20 million in Adjusted EBITDA this year - so valuation comes down, at the moment, to revenue. And, on that front, even at $100+ ROKU stock doesn't look ridiculously expensive.
After all, ROKU is valued at just over 11 times its revenue. That's a big number, obviously, but not huge in context. Shares of Shopify (NYSE:SHOP), another consumer-focused platform play, are valued at over 20x sales. (SHOP has some valuation concerns, too, admittedly.) Square (NYSE:SQ) is at about 12x its 2019 guidance for adjusted revenue (which backs out transaction costs). Even Netflix (NASDAQ:NFLX), a more mature company, is valued at over 10x sales (including debt).
This is not to say that ROKU is, thus, cheap. But 11x revenue, on its face, isn't obviously illogical. Given that revenue rose 51% in first quarter and is expected to grow 40%+ for the full year, a big multiple makes some sense. Whether "big" means 7x or 11x or 15x likely depends on the type of investor making the case.
But there's a catch here. About one-third of this year's revenue, per Roku management, is coming from the sale of players. And that revenue is not worth 11x - or anything close. Roku likely loses money on player sales: gross margin was 9.8% in Q1 and just 2.4% the quarter before. Combined, the company earned $10 million in gross profit in those two quarters - and spent $106.7 million just on research and development, much of that spend taking place in the hardware business.
It's the platform revenue investors want to buy - and that revenue this year will only be about $700 million by management estimates. That figure suggests that Roku is trading for a "true" revenue multiple of about 16x. That certainly gets closer to obviously illogical.
Is Roku's Business Good Enough?
In other words, the only remotely comparable stock that is valued more dearly than Roku is probably Shopify. SHOP has gone on a historic run - it's gained 120% year-to-date - and benefits from a likely larger market opportunity. Logically, Roku should trade at a discount to SHOP, but the current gap isn't that big.
Is Roku as a company that good, where it's dearly valued even in the rarefied air of fast-growing platform and/or software plays? Perhaps. It's benefiting from the disruption of video content consumption - and driving some of that disruption itself. The Roku Channel has a clear opportunity. Advertisers continue to flock to its platform. Users are growing, as are hours streamed: the latter figure rose nearly 80% year over year in Q1.
All that said, there are some question marks here. Roku still gets immaterial revenue from Netflix and YouTube, which remain the favorite apps among Roku users. The Roku Channel is intriguing - but it doesn't take a long look at stocks like CBS (NYSE:CBS) or AMC Networks (NASDAQ:AMCX) to see what investors think about ad-supported video at the moment.
What's intriguing about Roku is the reason I compared it to Amazon: we don't really know where Roku is going to go, or what it will look like a few years from now. With 29 million accounts, Roku has a base for new initiatives in video or even music streaming. It still has room to go international. Roku can find new ways to add value.
But there are still questions about what the business is right now. One-third of revenue is unprofitable. A decent chunk of the remainder comes from the Roku Channel, which potentially puts Roku at odds with some of the offerings on its platforms (think so-called vMPVDs like YouTube TV or DIRECTV NOW from AT&T (NYSE:T)). This isn't a perfect story yet. But the ROKU stock price suggests that it is.
A ROKU Pullback?
And so there appear to be two near-term risks to the ROKU stock price. The first is that investors question whether paying 15x+ revenue for any stock is wise. We may not see a repeat of the December sell-off that led ROKU shares to plunge, but a correction - particularly in high-growth names - wouldn't be a surprise.
The second is that investors keep paying up for quality, but decide Roku doesn't quite belong in the upper tier of growth stocks. That's my sense at the moment, and the key reason for caution above $100. Almost everything has to go right for Roku to keep moving higher - both in terms of its performance and in overall investor sentiment.
That seems like too much to ask in this market - and maybe too much to ask of this business.
As of this writing, Vince Martin has no positions in any securities mentioned.
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