Could Roku Stock Be Heading for a Correction?

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If you bought $1,000 of Roku (NASDAQ:ROKU) stock at the very end of 2018, it’s now worth $4,320. That’s a spectacular return of 432%. 

As Comcast's Attack Is Repelled, Roku Stock Looks Better Than Ever

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After having more than quadrupled in less than 11 months, it seems ROKU has to be ready to pull back. Doesn’t it?

On the one hand, the valuation of Roku stock is high, but on the other, it has consistently risen in 2019.  Also important to consider is that Roku stock price appears to have outrun the company’s user growth.

The Valuation of Roku Stock Is Stretched

Several InvestorPlace contributors, concerned about the company’s valuation, have maintained that ROKU has become overvalued in the days since it reported its third-quarter results on November 6. 

Chris Tyler, who specializes in technical analysis of stocks, suggested that the company’s 22-cent loss, which was 145% higher than a year earlier, had a big part to play in the stock’s  16% single-day decline.

I believe ROKU stock is setting the stage for a well-supported, corrective double bottom near $100. And if market conditions worsen or become more opportunistic, depending on your view, an even larger correction which tests $80-$85 certainly can’t be discounted,” Tyler wrote in an article published on Nov. 13. 

Fortunately for the owners of Roku stock,  Chris’ prediction has yet to come to pass. ROKU has managed to claw back those losses, and it is now $21 higher than where it traded before the post-earnings correction. 

Another InvestorPlace columnist, Mark Hake, has taken a more fundamental approach to analyzing Roku stock. 

Hake believes that, because the streaming platform’s sequential growth is slowing, investors are currently paying for the company’s past growth of 50% per quarter, while Roku’s year-over-year growth is likely to slow meaningfully

Furthermore, Hake describes a hypothetical scenario in which ROKU’s revenue grows 20% annually for the next three years, and its enterprise value is 8.3 times its sales at the end of those three years. In that case, he says, its adjusted EBITDA margins, excluding certain items,  would have to double from 3.5% today to 7% by the end of 2022 just to justify today’s enterprise value of $15.7 billion.

Finally, Luke Lango, who thinks that ROKU will be very successful for years to come, believes that its shares are fully valued.

Luke’s 2019 price target on ROKU stock is between $150 and $160. That’s  based on his 2025 earnings per share  estimate of $7.25, a 2025 price-earnings multiple of 35, and a discount rate of 10%. 

ROKU Has Consistently Climbed

Roku stock has consistently  advanced for most of 2019. As recently as Sept. 9, Roku traded at an all-time and 52-week high of $176.55 before falling below $100 in late September. 

Those who bought ROKU below $100 are looking at a 61% return over less than two months, and that includes its latest correction.

In May, I argued that ROKU stock could get to $200 by May 2024. At the time, it was trading around $84 after a 28% single-day jump, thanks to its strong first-quarter earnings. 

My rationale for believing that ROKU could generate an annualized return of 25% over five years was primarily based on its ability to increase its advertising revenue. However, I’m concerned about the company’s ability to attract enough active users and log enough streaming hours to justify the rates it’s charging advertisers. 

In Q3, Roku’s active user base rose 5.6% versus the previous quarter and 36% year-over-year. ROKU finished Q3 with 32.3 million active accounts. I wrote that it has to get to 82 million accounts or higher to justify a $200 share price. 

But it looks like Roku stock could get to $200 long before ROKU has 82 million accounts. 

The Bottom Line on ROKU

I like Roku stock.And I believe that, by expanding overseas,  ROKU can reach 82 million active accounts in around 4.5 years.  But I have to agree with some of my colleagues that ROKU stock has gotten ahead of itself. 

I would not advise long-term investors who already own ROKU to sell their shares.  But I would recommend that they put aside some cash to buy more shares if the stock drops meaningfully in early 2020. Last year, Roku underwent a big correction in the final quarter of the year. That doesn’t look like it’s going to happen this year. However, it could occur in the first quarter of 2020. 

ROKU is worth buying for long-term investors, but they can probably get a better entry point.

At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

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