Last week, gaming and social platform Roblox (RBLX 0.89%) released its first quarterly report as a public company. The builder of virtual shared worlds (otherwise known as the Metaverse) had an action-packed report, showing investors why its business is firing on all cylinders.

Management is expecting a slowdown in growth coming out of the COVID-19 pandemic. However, if you take a multi-year time horizon and look at all the investments Roblox is making in its platform, you can see that this business has a long runway to grow. Here's why.

The results were impressive

In the first quarter ending in March, Roblox had $387 million in sales, up 140% from the prior year, while posting a net loss of $134.2 million. The platform had average daily active users (DAUs) of 42.1 million in the quarter, up 79% from the year before, and customers spent 9.7 billion hours on the platform.

A kid holding up a phone looking at a virtual augmented reality object.

Image source: Getty Images.

Diving deeper, DAUs over the age of 13 grew 111% to 20.5 million in the quarter, and DAUs outside of the U.S. and Canada grew 87%, which were both faster than overall DAU growth. These numbers are a key metric for evaluating whether Roblox can attract an older and more international audience to its platform.

One concern investors might have is the giant net loss of $134.2 million that Roblox posted in the quarter. This number is misleading, though, because Roblox actually generated a lot of cash in Q1.

How is this possible? It's simple. Under GAAP accounting standards, the company is forced to defer sales and recognize them over a 23-month period, even if it collects all the cash upfront.

While Roblox posted a $134.2 million net loss in Q1, its cash generated from operating activities was $164.5 million, and free cash flow was $142.1 million. Operating cash flow and free cash flow are the two key metrics in evaluating the profitability of Roblox due to its high levels of deferred revenue. In Q1, it knocked it out of the park on both fronts.

What makes Roblox's cash generation even more impressive is its ability to generate cash while simultaneously investing for future growth. It's building out its own cloud infrastructure, investing in trust and safety, and adding more immersive avatar-building tools.

Avatar technology and accessories are a huge growth driver for Roblox. On the conference call, management said its vision is to allow developers and users to have anything from cartoon characters to lifelike features when customizing their identities within the Roblox virtual worlds.

Other growth opportunities

Outside of its core marketplace where users/players pay developers for tools and access to games (of which Roblox takes a cut), the company is also investing in new ways to make money from the platform. Luxury-brand Gucci is partnering with Roblox to create items on the platform, and Hasbro is bringing Nerf and Monopoly products onto Roblox sometime this year.

Roblox is also entering China, the world's largest gaming market, through a partnership with Tencent and under a local brand called "Luobulesi." It's tough to tell how well this venture is going, but on the conference call, management mentioned that Chinese developers have broken into the top 250 of developers worldwide, indicating that the business has made some inroads into the notoriously tricky Chinese market.

Another growth opportunity would be to bring Roblox onto other consoles and hardware like the Nintendo Switch, Sony Playstation, and Facebook's Oculus Quest (it's currently not available on any of these devices). When asked about it on the conference call, CEO David Baszucki said the company's current focus is to invest rapidly into the smartphone market, but it also wants to be accessible on all devices in the future.

What about the valuation?

Roblox currently trades at a market cap a tad below $40 billion. Extrapolating last-quarter's $142.1 million in free cash flow out to a full year, Roblox trades at a price-to-free-cash-flow ratio (P/FCF) of 70, which is much higher than the average stock in the S&P 500 index. However, once you consider the heavy investments the company is making into infrastructure, trust and safety ($64 million just last quarter), and the payments to the developer community (they have a goal of $500 million in 2021), Roblox has an opportunity to meaningfully grow its annual cash flow over the next decade. 

The company still needs to grow substantially (both users and revenue) in order to fulfill its lofty valuation. However, if management can execute by growing into older age groups and internationally, a $40 billion market cap for Roblox could look like a steal a few years from now.

With all the volatility in growth stocks at the moment, Roblox looks like a prime candidate for the "buy in thirds" strategy. If you like the business, it could be prudent to take a small position now and then either wait for the company to continue executing or for the price to fall even further before adding to your position.