Roblox (RBLX 1.60%) enjoyed a brief period as a stock market darling following its March 2021 initial public offering. But the story surrounding the stock has changed as growth has slowed and turbulence has roiled the broader market. The gaming and metaverse company's share price has tumbled 64% across this year's trading, and it's off 72.5% from the peak it hit late last year.
Should investors treat the dramatic valuation pullback as a buying opportunity, or would it be smarter to stay far away from this volatile growth stock? Let's take a look at the bullish and bearish arguments for the stock and try to determine what comes next for Roblox.
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Bear case: Roblox is not a profitable business
Parkev Tatevosian: Roblox did an excellent job acquiring users to its metaverse platform, but it wasn't all that hard considering the popular gaming platform is free to join and use. Roblox generates revenue by selling these users an in-game currency called Robux which provides them access to premium items and experiences.
While revenue has risen swiftly at Roblox for the last several years, the company has had a tougher time returning profits to shareholders. To reduce employee expenses but still attract employees, the company pays a significant share of its employees at least some of their salaries using stock-based compensation. This increases Roblox's share count and dilutes shareholders' stock value.
Roblox's weighted average shares outstanding have increased nearly 37% in just the past year. When Roblox finally does start earning profits, those profits will be divided across a broader shareholder base. This lowers per-share earnings, which investors don't like to see.
Another issue that has the bears somewhat worried is Roblox's business model. Roblox outsources the creation of much of the virtual items and experiences on its platform to the users themselves. These user creations are purchased or accessed by other users through the exchange of Robux (purchased from the company). The developers can then exchange the Robux they earn on their creations for actual money from Roblox using a formula of shared profits. In this way, Roblox minimizes development costs for the various experiences on its platform and only has to share revenue with developers for content that users appreciate. Despite this business model that reduces costs and seemingly increases quality by paying only for popular experiences, Roblox's losses on the bottom line are increasing.
Roblox might be excellent at acquiring users, but it has so far shown that it is not so great at generating profits. As an investor, that's a losing proposition.
Bull case: Roblox's foundation is very promising
Keith Noonan: Roblox did have real performance declines caused by a softening of pandemic-related tailwinds and perceived declines caused by challenging comparisons to very strong performances in 2020 and 2021. But it looks like Roblox is shifting back into growth mode. The company released a report last week that estimates its bookings grew between 5% and 7% year over year in August, and its daily active user count jumped 24%. Average bookings per daily active user are projected to fall roughly 15% at the midpoint, but that looks much less concerning in the context of strong user growth and the end of social distancing conditions in most of the world.
While Roblox's business performance otherwise looked underwhelming along key metrics for much of this year, the company has a large user base and untapped long-term growth potential. By allowing creators to monetize their content, Roblox set up powerful incentives to ensure that its platform continues to offer new content and experiences. Compared to other gaming platforms and metaverses, this sets the stage for Roblox to have more longevity.
Supporting continued user growth and engagement will pave the way for a shift into profitability, and Roblox is already gearing up to launch new monetization modes. The company plans to roll out in-platform advertising next year, and the new monetization avenue has the potential to be a real game changer. Total hours of user engagement on the platform increased 18% year over year in August to reach 4.7 billion, and the introduction of ads will bring the company new ways to generate high-margin revenue from its hugely popular virtual world.
Thus far, Roblox has concentrated on broadening the appeal and reach of its platform, but it could be laying the foundation for strong earnings growth over the long term. The longer the platform can keep users engaged, the more this company's current valuation will start to look very cheap.
Should you buy Roblox stock today?
Even after its precipitous valuation pullback, Roblox isn't a low-risk stock. The company has a growth-dependent valuation and is operating in a young, yet-to-be defined niche in a highly competitive industry. If you think the business will have trouble getting back on track for long-term growth or are put off by the potential for outsize volatility, Roblox stock probably isn't a great fit for you.
On the other hand, Roblox has created a highly engaging platform and could play a leading role in pushing the overall metaverse trend forward. For risk-tolerant investors looking to benefit from the rise of virtual worlds, the stock could go on to be a big winner.
