What happened
Is Roku (ROKU 1.58%) stock grossly overvalued? That's a question a lot of investors are asking. And one Wall Street analyst just suggested this stock has roughly 50% more downside, which is saying something considering the stock is already down about 60% from its all-time high. This is partly why, as of the market's close on Thursday, Roku is down 15.1% for 2022.
So what
According to The Fly, Atlantic Equities analyst Hamilton Faber started covering Roku stock earlier this year. Faber started his coverage by slapping a $136-per-share price target on Roku, a roughly 50% downside from where it was trading at the time. Faber believes Roku will struggle to attract TV manufacturer partners for its connected-TV operating system software. For this reason and more, Roku stock doesn't deserve its pricy price-to-sales (P/S) valuation of 10.5, Faber said.
Image source: Getty Images.
Now what
Let's talk about Roku's business. According to the company, it closed 2020 as the most widely adopted operating system for smart TVs in the U.S. with 38% share of new TVs sold. And in the third quarter of 2021, Roku's 56.4 million active accounts streamed 18 billion hours of content. Both the number of active accounts and the number of hours streamed were up year over year.
It's worth monitoring how well Roku is attracting partners, as Faber suggests. But considering Roku is still executing well, I believe investors should give it the benefit of the doubt for now.
Regarding valuation, if Roku stock fell 50% from here, it would trade at a P/S of roughly 5. Coincidentally, this is about what its valuation was when it went public in 2017. However, back then, Roku's business was more heavily skewed toward its low-profit-margin hardware business. These days, its high-margin software business is in the driver's seat, boosting the company's overall profitability.
Roku's gross margin for the first six months of 2017 was 38.2%. In the third quarter of 2021, it was 53.5%. Because its profitability has improved, assessing its current valuation and its past valuation isn't an apples-to-apples comparison -- higher-profit-margin companies generally have higher P/S valuations. For this reason, I think Roku's valuation is fair today, provided at can continue to gain new active accounts and increase its user monetization.
