Roblox (RBLX 1.35%) stock has made a solid comeback of late, surging by more than 50% after touching its 52-week low of around $25 in September.
The company delivered a solid performance in 2023, with revenue and bookings improving by 26% and 23%, respectively. Investors were delighted as these numbers suggest the worst of its headwinds could be behind it.
Still, before investors rush into the stock, there are two critical risks that they should be aware of now.
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A short track record as a public company
Roblox is a classic example of a solid growth stock. The video game company almost doubled its quarterly revenue from $387 million in the first quarter of 2021 to $750 million in the final quarter of 2023, less than three years after it went public in March 2021. Except for a brief period in the second half of 2022, its revenue has grown at double-digit and triple-digit percentages.
Yet, I still have reservations about the company's short track record for two reasons. First, it's difficult to make reliable predictions about Roblox's performance with the limited information available. Second, the lack of historical data makes it harder to assess the management team's will and ability to navigate different business cycles and challenging times.
It doesn't help that Roblox remains a loss-making business despite its rapid expansion over the years. While it is common for high-growth companies to invest heavily in the short term to gain market share (think Amazon), Roblox's brief operating history adds another layer of uncertainty for investors.
On a slightly positive note, Roblox's solid performance in 2023 provides some assurance about the viability of its business model. All key metrics -- including bookings, revenue, daily active users, and engaged hours -- improved by double-digit percentages year over year, suggesting that its slowdown in the second half of 2022 was temporary.
Besides, Roblox generated a positive operating cash flow of $458 million, up 24% year over year. This suggests that further improvement in operating leverage and future growth could finally turn the loss-making company around.
While Roblox's recent performance provides some good indicators about management's ability to deliver growth and generate positive cash flow in the short term, investors will still need to see that performance sustained over a longer term.
The stock trades at a premium valuation
The second risk for new Roblox investors is the company's high valuation. As of this writing, the stock trades at a price-to-sales ratio of 8.6. While this ratio is below its 5-year average of 15.9, it remains high compared to other leading technology companies. For instance, Alphabet trades at a price-to-sales ratio of 5.6.
While Roblox bulls may justify that high valuation based on the company's growth potential, arguing that its long-term target of reaching 1 billion daily active users -- it had 68 million in its latest reported quarter -- would create enormous value for shareholders.
But here's the thing. To reach that long-term target, Roblox will have to rely on the metaverse becoming mainstream. This is not a sure thing since the future of that nascent industry will depend on many factors, including technology development, regulatory support, hardware and software integration, etc. On top of that, competition is intense, with companies like Meta Platform going all in on the metaverse.
If Roblox fails to live up to expectations on its growth plan or faces challenges in its execution, the stock's valuation could contract to reflect the new reality, temporarily or permanently. The former would bring unnecessary volatility to investors' portfolios, while the latter would lead to an impairment of capital.
What it means for investors?
Roblox's solid growth in 2023 should remove investors' concerns about the viability of its business model. Still, buying its stock today is not without risks. Investors must be willing to accept the drawbacks of investing in a young public company. It doesn't help that the stock is trading at a rich valuation, offering investors little margin of safety.
So, except for a few willing to endure these risks, conservative investors may be better off keeping the company on their watch lists. They should only act after enough conviction, a lower entry price, or both.
