A bear market brings along with it plenty of potential opportunities for long-term investors. There will be easily scared investors and short-term traders who run for the exits, while disciplined and rational investors get a chance to buy stock from some fantastic companies that got caught up in the broader sell-off.
Be wary though: Market (and macroeconomic) downturns do often reveal companies whose stock price does not match their financial metrics, creating bargains. But some stock prices are down for very good reasons.
A stock with plenty of rise (and a significant fall)
There has been a lot of talk about the metaverse lately and about companies working to take advantage of this hot new trend. This digital, three-dimensional world (or worlds) will be immersive and accessible in real-time by an unlimited number of people and it will allow for social interactions, commerce, and more. The metaverse concept also involves a range of virtual reality (VR) and augmented reality (AR) scenarios. Roblox (RBLX -0.59%) is currently building up its game venue in the metaverse. The technologies its developing also have metaverse-related potential beyond gaming.
Right now, Roblox's platform enables users to play and create games, and it gained a lot of new users during the start of the pandemic as other entertainment venues closed temporarily. Roblox added millions of daily active users (DAUs) in 2020 and 2021. Investors got excited and it became a "pandemic stock."
By November 2021, the stock was trading at $141.60 a share. Since then, its price has fallen 75% (64% just in 2022). As pandemic shutdowns eased, many of these so-called pandemic stocks lost their luster. The ones that managed to sustain growth and improve metrics went on to become potential good buys. Unfortunately, Roblox is not one of these.
Roblox revenue growth is slowing
Newer public companies tend to get some leeway from investors on becoming profitable because investors understand that growth takes priority early on and it comes at a price. They are willing to get in early, let management invest wisely in growing the business, and reap the rewards down the road. But what happens when the growth abruptly slows?
Roblox's year-over-year revenue growth has gone from 140% to 30% in just five quarters (see chart below).
Data source: Roblox. Chart by author. YOY = year over year.
Tough year-over-year comparisons are understandable when growth is so outsized in the prior year. It's also understandable that the rate will decrease somewhat as the numbers get bigger. But this relatively quick decline is troubling because these factors likely don't account for all of the decrease. Meanwhile, losses from operations grew by 19% in Q2. If this trend doesn't reverse quickly, more shareholders will depart. Unfortunately, bookings suggest this is not likely.
Roblox bookings are going backward
The main way Roblox makes money is by selling Robux (its virtual in-game currency) to its users. Roblox refers to the revenue attained from Robux as "bookings." That's because it cannot be counted as actual revenue until the user spends the Robux on the gaming platform. The level of bookings can tell investors a lot about user engagement and company momentum. It can also be a warning sign of trouble. For instance, less Robux spending could suggest users are becoming disinterested in the product. Less purchasing of Robux could suggest the troubled economy is taking its toll on users' ability to buy Robux.
The news on bookings isn't encouraging. Roblox reported its second consecutive quarter of a small year-over-year drop in bookings in Q2 2022 (see chart below).
Data source: Roblox. Chart by author.
Roblox's earnings before interest, taxes, depreciation, and amortization (EBITDA) and its cash from operations also fell to their lowest level since the first quarter of 2020. Free cash flow was negative in the last quarter.
Caution is warranted on Roblox stock
Despite the significant stock price drop this year, Roblox stock still trades at a higher price-to-sales ratio than fellow metaverse company Unity Software. Both stocks are also contending with negative consumer sentiment, investors wary of growth stocks, and an economic down cycle.
Roblox was far from profitable during the pandemic heyday, but it was doing better in that regard than it is now. Many investors accepted the lack of profit because the company was young and still generating tremendous growth. For many of these investors, Roblox was the next big thing and it was time to get on board. But that growth has hit a significant speed bump and could disappear altogether in the coming quarters if trends continue. This could easily lead to more losses for shareholders unless management finds a way to give the company a serious boost.
The current bear market discounts many stocks, including some unfairly. Not all are good buys, even as long-term speculative investments. Those looking at Roblox should do careful due diligence before considering this stock.
