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1 Lesson You Should Learn From Roku's Earnings Report

By Anders Bylund - Nov 7, 2019 at 11:47AM

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"Good enough" isn't always good enough, especially when you're looking at a high-flying market darling. Welcome to the growth-stock corner of Wall Street.

Streaming media specialist Roku ( ROKU -2.24% ) reported third-quarter results last night. It was a solid effort by all accounts, meeting or beating Wall Street's estimates and paired with a boosted management view of Roku's full-year results.

Yet the stock fell 15% on the news. Roku shares plunged immediately after the report, stayed down throughout the after-hours trading session, and still suffered a 15.7% haircut at Thursday's opening bell.

I'm here to tell you that this isn't the end of the world for Roku investors. This was actually a fairly standard response to a merely solid earnings report from a company like Roku. Some investors would call it a predictable buying opportunity, even.

Here's how.

A young man sits on a couch, facing an unseen TV screen with the remote in his hand and a drop-jaw look of either excitement or terror on his face.

Image source: Getty Images.

Roku's third quarter by the numbers

There really wasn't much wrong with Roku's third-quarter results. Net revenue rose 50% year over year, landing at $261 million. A 36% uptick in the number of active user accounts drove a 68% increase in media-streaming hours performed on Roku's hardware and software platforms during this period. And that growing user base is generating more revenue per account, too. Average revenue per user (ARPU) increased by 30% to $22.58 per year.

The results compared nicely to Roku's financial forecasts for this period, exceeding the top-end value of every guidance range. Revenue was supposed to rise no higher than $255 million but actually stopped at $261 million. Management expected a net loss of $34 million or more, along with negative adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of at least $5 million. Instead, the company reported a smaller net loss of $27 million and effectively a break-even reading on the EBITDA line.

Yes, that was good enough to leave analyst estimates in the dirt. The consensus estimates had called for a net loss near $0.28 per share on sales in the neighborhood of $256 million. You should know the $261 million top-line number by heart at this point, and Roku's net losses worked out to just $0.22 per share.

Management also raised its full-year revenue guidance by 2%. What's not to love?

Investors were hoping for more!

That's the object lesson hidden in Roku's earnings report. "Good enough" isn't always good enough on Wall Street. In fact, even a modestly positive surprise isn't always enough to support a company's share prices when they enter the report on a full head of steam, setting the bar for investor expectations far above the estimates provided by analysts or official guidance targets.

That's exactly what is going on with Roku today. Going into this report, Roku's stock had gained a thrilling 148% over the past 52 weeks. Shares were trading at 2,400 times the company's free cash flow, 18 times sales, and (gulp!) 35 times Roku's total book value. And investors were paying these ultrapremium prices for a company that reports consistently negative earnings.

Welcome to the world of investing in extreme growth stocks. Your earnings expectations are of little value here, and even cash flow can wait for a few years. Roku's No. 1 job at this stage is to keep optimizing its strategy for maximum growth in user accounts and revenue -- the rest will come later.

Will it, really?

So there's the rub. Roku's stock is plunging today because the company failed to utterly impress investors with a merely passable earnings report.

By "passable," I mean nothing more than 50% sales growth and a 38% larger user base. Many companies would kill for that kind of extreme momentum, but Roku's stock had simply soared too high to enjoy any support from those numbers.

So a few Roku investors are pocketing some profits today, perhaps planning to buy those shares back again later on. Or maybe they won't if the company fails to spark enough revenue growth in future reports to remain interesting to investors in pure hypergrowth stories.

The rest of us can sit back and reconsider Roku's value at 13 times trailing sales. If you believed in Roku's business model before this report, the company did nothing to lose that trust in the third quarter. Growth stocks aren't every investor's cup of tea, but this sudden discount may have unlocked a fine buying window for opportunistic Roku watchers.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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