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Let me start by stating that I'm a big fan of Roku (NASDAQ: ROKU ) - this is a winning business with a winning strategy in a secular growth market, positioned for big user, revenue, and profit growth over the next several years, the sum of which should power ROKU stock higher in the long run.
These winning attributes were on display when Roku reported blowout second-quarter numbers last week .
The report comprised ~40% active account growth (which was above expectations), ~70% aggregate streaming hours growth (above expectations), 25%-plus average revenue per user growth (above expectations), ~60% revenue growth (above expectations), and 55%-plus adjusted EBITDA growth (also above expectations). Management also issued an above-consensus third quarter and full-year 2019 guide.
Even further, Roku reported the strong numbers only a few weeks after Netflix (NASDAQ: NFLX ) reported an awful quarter. In other words, the whole "Roku is winning only because Netflix is winning" thesis got thrown out the window.
Instead, Roku is standing on its own two feet and is winning because this company is transforming into the cable box of the streaming TV world.
All in all, it was a great report which underscored the stock's secular bull thesis. In response, the stock soared. As of this writing, ROKU trades hands at about $13o, up nearly 35% from the Q2 print and up 340% year-to-date.
Despite all that great news, this long-time bull (I really started pounding on the table to buy ROKU stock back in late 2018 / early 2019 ) is starting to take profits. Here's why.
The Valuation Is Stretched
I've been doing some trimming in ROKU in August because at current levels, the stock's valuation is too stretched relative to the fundamentals.
The bull thesis on ROKU stock is simple. Roku is turning into the cable box of the streaming world. That means two things. A bunch of subscription sharing dollars, and a bunch of streaming TV ad dollars. Roku is already racking up both of those.
They will continue to do so over the next several years as: 1) more and more consumers migrate to the streaming channel, and 2) more and more ad dollars flow from linear to streaming TV.
Further, both of those revenue streams are high margin (60%-plus gross margins), so the pathway to big profits at scale has tremendous visibility. The only problem is that the potential profits this company could produce at scale, do not justify much further near term upside in ROKU stock.
Roku has a realistic runway to grow active accounts by ~25% per year to 130 million by 2025. ARPU has a realistic runway to grow 10% per year to $35 by 2025, given the secular pivot of ad dollars from linear to streaming TV. Revenues could consequently grow at a 30%-plus rate to over $5 billion by 2025. Margins should run significantly higher long term thanks to increased scale.
Even under all those optimistic assumptions, my best case scenario for 2025 EPS is $7. Based on an equally aggressive 35-forward exit multiple (which is average for application software stocks ) and a 10% discount rate, that equates to a 2019 price target for ROKU stock of $150.
Thus, even in a best case scenario, ROKU has a runway to just $150 by the end of the year.
The Momentum Is Real
I haven't sold my entire ROKU holding, and still am holding a core position, because this stock has a lot of momentum right now and could keep this momentum for the foreseeable future.
Zooming out, we have a market right now defined by still strong labor conditions and low rates. That sort of environment is perfect for growth stocks. Strong labor conditions support continued robust consumption, which supported sustained big profit growth. At the same time, low rates support bigger multiples on stocks and make growth stocks look relatively less richly valued.
As such, in today's market, stocks with good growth narratives are marching higher. It's that simple. With rates so low, investors are seemingly turning a blind eye to valuation and focusing exclusively on long term growth potential.
This is an advantageous dynamic for ROKU stock. Valuation is a problem here, yes. But, the growth story is as hot as ever, and the momentum behind the stock is as powerful as ever.
So long as rates remain low, then, this stock should grind higher. With rate cuts on the horizon, rates project to stay lower for longer. As such, ROKU projects to move higher for the foreseeable future based on momentum alone.
Bottom Line on ROKU Stock
ROKU is a long term winner. But, with the stock up 340% year-to-date and closing in on a best-case scenario 2019 price target, now seems like a good time to some more profit-taking and become a little a more cautious on the name.
To be sure, that doesn't mean it's time to sell everything. I rarely like to fully exit long term growth winners, especially with rates so low. As such, so long as interest rates remain depressed and the narrative here remains hot, I'll hold onto my core position, trim more on big rallies, and buy more on big dips.
As of this writing, Luke Lango was long ROKU and NFLX.
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