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Is Roku Stock Overvalued?

By Daniel Sparks - Dec 3, 2019 at 9:30AM

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One analyst thinks so. But is he underestimating the streaming-TV platform specialist's long-term growth story?

After rising more than 400% year to date, Roku ( ROKU -2.24% ) stock is overvalued, argued one analyst on Monday. The analyst's note sent Roku shares sliding. The stock fell 15% by the time the market closed.

Is it time for investors to take their profits on this streaming-TV platform specialist's stock? Or is there more upside ahead for shareholders willing to hold Roku shares for the long haul?

While the stock certainly commands a premium valuation, investors should think twice before they sell based on Roku's stock's strong year-to-date performance. Here's why the stock may not be as pricey as it seems at first glance.

A young woman eating popcorn and watching TV in her living room

Image source: Getty Images.

What's behind Roku's soaring stock price?

While a 400% run-up (about 350% after accounting for Monday's sell-off) and a price-to-sales ratio of 16 for the stock might seem absurd on the surface, investors should realize that Roku's underlying business is seeing wild growth.

First, there's Roku's recent acceleration in top-line growth. After growing revenue by 45% year over year in 2018, Roku grew first, second, and third-quarter revenue by 51%, 59%, and 50%, year over year, respectively. Meanwhile, the company's' gross profit is soaring. Trailing-nine-month gross profit jumped 52% year over year to $333.6 million.

Sure, Roku's gross profit margin has been contracting recently. Roku's trailing-nine-month gross profit margin is 46%, down from 47% in the same period last year. But that's only because Roku is willing to invest in areas that lead to a lower a gross profit margin as long as those investments drive outsize gross profit growth over the long haul.

So far, this strategy has paid off handsomely. Indeed, Roku has repeatedly raised its full-year gross profit target this year as previous platform investments are paying off nicely. Currently, Roku expects full-year gross profit to be between $489 million and $494 million. Not only is this up from $332 million in 2018, but it's also well above management's initial outlook for 2019 gross profit to be between $445 million and $460 million.

A massive and compelling addressable market

In addition to taking the time to understand Roku's improving fundamentals, investors should appreciate Roku's incredible addressable market, particularly when it comes to connected TV advertising. Currently, over $70 billion is spent annually on ads for traditional television in the U.S., according to data from eMarketer. Yet eMarketer estimates just $7 billion will be spent on connected TV ads in 2019, up 38% year over year -- and that figure is expected to surpass $10 billion by 2021.

It's inevitable that a larger share of marketers' ad spend shifts to connected TV, as viewing time is already shifting. Magna Global forecasts that nearly a third of TV viewing already takes place on connected TV. Further, connected TV obviously offers more targeting capabilities for marketers, making the ads more valuable than ads on linear TV.

"We believe that we are well positioned to benefit from this trend," said Roku in the company's fourth-quarter shareholder letter when discussing shift of traditional TV advertising spend to connected TV.

Roku's skyrocketing monetized video ad impressions certainly back this up. The company's video ad impressions have been more than doubling year over year in recent quarters.

While Roku shares certainly aren't cheap, robust fundamentals and an extraordinary addressable market don't make shares look overvalued either.

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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