Saying Roku (ROKU -10.29%) stock had a good last week would be a massive understatement. Shares surged more than 50%, fueled by the company's better-than-expected third-quarter update and management's upbeat view for its business headed into the holidays.
Following the report, analysts have rushed to upgrade their 12-month price targets for the growth stock. One of the most bullish updates came from DA Davidson. The investment banking firm increased its 12-month price target for the stock by $11 to $101.
Let's see why DA Davidson's Tom Forte is so bullish on the stock.
Advertising is on the upswing
As Forte explained in his note to investors on Thursday, Roku's third-quarter revenue and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) were better than analysts were anticipating. Revenue for the period increased 20% year over year to $912 million, easily beating analysts' average forecast for $853 million. Further, Roku's adjusted EBITDA came in at more than $43 million -- up from approximately negative $34 million in the year-ago quarter.
But it wasn't just the good results that have Forte more bullish on the stock. Additionally, Forte was encouraged by management's commentary about a stabilizing digital ad market and a rebound in video advertising -- even in the face of a challenging macroeconomic environment.
Bolstering Forte's bullish view for a stabilizing ad market, Roku management said it expects the year-over-year growth rate in video advertising on its platform to be just as strong in Q4 as it was in Q3.
Key risks
Though Forte's bold call for the stock is notable, there remain some key risks for Roku stock worth exploring.
One of the main risks is the stock's valuation. The company's $12 billion market capitalization is a steep price to pay for a company still losing money on a generally accepted accounting principles (GAAP) basis.
For the company to live up to its valuation, investors should first look for it to deliver strong double-digit revenue growth consistently going forward. While it's encouraging to see the company's top-line growth rate accelerate from 11% in Q2, the stock's current valuation demands top-line growth rates in the mid- to high teens or greater for years to come. So, investors should look for Roku to keep delivering strong growth in the coming quarters.
Notably, however, growth may have to decelerate a bit before it accelerates. Management warned that even though it expects its momentum in video ads to persist in Q4, it faces a difficult year-over-year comparison in its content distribution and media and entertainment spend on its platform.
Additionally, the stock's high valuation demands Roku not just grow revenue rapidly but also improve profitability to the point that it is reporting meaningful GAAP profits -- not just improving EBITDA. Investors should ideally look for GAAP profits from Roku by the end of next year.
Forte is right about Roku's business looking better after the company's strong third-quarter update and management's report of a strong rebound in video ads. But to say Roku stock is headed to $101 is arguably a stretch at this point. Investors may want to tread carefully with this stock following its 50% rise last week. A high valuation may have already priced in much of the company's growth story.
