Streaming media facilitator Roku (ROKU +3.15%) joined the public stock market 11 months ago. In that short span, share prices have skyrocketed 170% higher. The market momentum is strong with this one.
But the rising stock chart also makes current and prospective investors worry about how far the shares could fall if something goes awry. How risky is Roku's stock today?
By the numbers
By pretty much any valuation metric you like, Roku's stock is crazy expensive. Shares are trading at 11 times trailing sales and 31 times the company's book value, and it's impossible to peg a P/E ratio or any cash flow-based valuation on Roku -- both its earnings and cash flows are negative.
I suppose you could weigh Roku against its minuscule EBITDA profits, which clocked in at $230,000 over the last four quarters. But the numbers you get out of measuring a $6.5 billion enterprise value against that barely-there profit line aren't very helpful. Any sane value investor would run away from a stock trading at 2.8 million times trailing EBITDA.
On the other hand, Roku keeps its balance sheet squeaky-clean. The company carried $174 million of cash equivalents at the end of June and paid off all of its long-term debts with last year's influx of IPO cash.
Furthermore, Roku's gross margins are expanding quickly. Over the last four quarters, the company carried 43.6% of its top-line revenues over into gross profits, up from 39% in fiscal year 2017 and 28% in 2015. Keep that up for much longer, and the company might start reporting actual profits someday.
Let's not forget about Roku's rampant revenue growth. Sales rose 57% year over year in the second quarter, accelerating from 37% in the first quarter and 30% in the period before that. These are the kind of hyper-growth numbers that make market darlings out of unprofitable businesses.
Image source: Getty Images.
Behind the numbers
The secret to Roku's recent success lies in a shifting business strategy.
Started by CEO Anthony Wood, who once served as vice president of internet-delivered video at Netflix (NFLX +2.68%), Roku's main goal was to provide set-top boxes with network connectivity to help Netflix drive its vision of a new market for streaming video. Those video players continue to account for a significant chunk of Roku's revenue stream, but the company also licenses its software platform to makers of smart TV sets, a much more profitable business.
That idea also addresses a large target market, delivering massive growth in these early days. Roku's software platform nearly doubled its second-quarter sales compared to the year-ago period, and that segment accounted for 58% of Roku's quarterly revenues.
How risky is Roku, then?
So, Roku is following spiritual parent Netflix with a similar strategy: Invest every penny of spare cash into maximizing the company's growth trajectory and get ready to shift into profit generation a few years down the road.
That makes the stock a very hard sell to strict value investors, but growth hunters should see a very different story, here. Roku's rapid sales growth is paired with widening gross margins, which should result in positive bottom-line results in the long run.
In short, this is one of the least risky companies I can think of in the category of businesses with negative earnings and cash flows. Things are moving in the right direction, and Roku's pristine balance sheet provides another safety net in case something goes terribly wrong with the platform software strategy.
