There are no two ways about it: Roblox (RBLX 1.28%) delivered a terrific earnings report on Monday, and it reaped the reward of that performance on Tuesday when its stock rocketed 42% in a single day.

But the news wasn't all good.

Group of fantastical avatars over company name ROBLOX.

Image source: Roblox.

Roblox's news

Before we discuss the pain point, let's briefly review Roblox's good news. In Q3 2021, the online gaming platform delivered:

  • A 28% year-over-year increase in bookings to $637.8 million. ("Bookings," in the context of Roblox, means "gamers buying Robux virtual currency to spend on in-game items later on.")
  • Another 28% improvement in "hours engaged," or the amount of time gamers spent on Roblox. As CEO David Baszucki explained, "Engagement is our north star," and it was one of the improvements he was most proud of in the quarter.
  • 31% growth in the average number of daily active users (DAUs).
  • A staggering 102% increase -- more than double -- in quarterly revenue to $509.3 million.

Granted, Roblox still didn't earn a profit on the bottom line, losing $0.13 per share instead. In fact, though, that's not what worries me. For one thing, the main reason Roblox lost money in the quarter is that it spent heavily in paying its game developer partners well, in spending on research and development, and in improving "infrastructure and trust and safety" -- all items I view as crucial investments for a company that aspires to be a growth stock.  

And for another, Roblox's losses, while significant, were only half as much as a year ago -- so the bottom line is improving.

So make no mistake: As a Roblox shareholder myself, I'm pleased with these numbers. And I'm especially pleased that Roblox was able to achieve this growth in comparison with a Q3 2020 in which it largely played to a captive audience of school kids stuck at home with little to do but play Roblox.

Roblox CFO Michael Guthrie boasted, "Notwithstanding significant investments in developer economics and hiring" -- and difficult comparisons to a "COVID-impacted" quarter" -- the company "generated healthy cash from operations."

But that's what really worries me: the cash.

What's wrong with Roblox

Consider: Back when Roblox was preparing for its IPO, one of the things I liked most about this company was its 50% free cash flow margin -- the fact that out of every $1 of revenue Roblox took in, it generated a cool $0.50 in positive cash profits. I was especially pleased to see that, in its first quarter as a publicly-traded company, Roblox was able to maintain this level of free cash flow profitability -- at least after backing out one-time costs of the IPO.  

 But what have we seen at Roblox since then? According to data from S&P Global Market Intelligence, Roblox booked revenue of $454 million in Q2 and free cash flow of $168 million. And in this just-reported Q3, Roblox reported revenue of $509 million and free cash flow of $178 million.

It only takes a little quick calculator work to determine that Roblox's free cash flow margin -- again, that's the amount of real cash profit it generates from $1 of revenue -- stumbled down to 37% in Q2, and then slipped even more in Q3, falling to 35%.

The upshot for investors

Make no mistake: With $488 million in positive free cash flow generated year to date, Roblox remains a cash machine. The company is still on track to churn out $650 million in cold, hard cash profit through the end of the year. Nevertheless, the past two quarters have shown a marked decline in Roblox's free cash flow margin -- down 15 full percentage points.

With its stock valued at an extremely high 87 times FCF, Roblox is already a high-priced stock. If its cash profitability continues to erode, I may have to consider selling and recalculate whether Roblox stock is still worth as much as it costs.