Markets

Roku Stock Plunges After Analyst Slashes Rating

Shares of Roku (NASDAQ: ROKU) had been on a tear in 2019. The streaming video device maker's stock had surged more than five times in value prior to Monday, following multiple quarters of impressive growth. Now, however, a notable investment firm thinks the shares have come too far, too fast.

Morgan Stanley downgraded Roku's stock on Monday from equal weight to underweight. Analysts at the investment bank say shares are too expensive -- and that investors are failing to account for significant risks.

A keyboard with the return button in red labeled sell.

Roku's stock is likely to underperform the market, according to Morgan Stanley. Image source: Getty Images.

Roku's sky-high valuation reflects "exuberance over all things streaming," according to Morgan Stanley analyst Benjamin Swinburne. He believes that after the stock's massive run-up, its risk-to-reward profile is "skewed to the downside." 

"Roku continues to execute a sound strategy to capitalize on the shift to streaming," Swinburne said. "However, we believe there are risks to growth expectations not reflected in current valuation levels." 

Swinburne expects growth in Roku's revenue and gross profit to decelerate "meaningfully" in 2020. In turn, he anticipates that Roku's price-to-sales multiple will compress, as investors will be less willing to pay such a large premium for its shares. 

"We think it will be increasingly difficult to sustain the current premium ... as gross margins fall and gross profit growth moderates," Swinburne said.

Intensifying competition

Powerful new rivals are entering the streaming hardware arena. Cable giant Comcast (NASDAQ: CMCSA) announced in September that it would give away free set-top boxes to its subscribers. Some analysts posited that more cable providers would follow suit, and others even questioned whether cable companies would eventually render a major portion of Roku's business obsolete.

Partially in response to these and other threats, Roku has expanded into digital advertising. It acquired digital ad platform Dataxu for $150 million in October to strengthen this fast-growing portion of its business. Dataxu's technology helps marketers plan and purchase video ad campaigns, maximizing their advertising investments in the process.

But here, too, Morgan Stanley sees challenges. Swinburne predicts that Roku's digital advertising growth will decelerate more rapidly than many investors currently expect. "This has been the case with other emerging digital advertising businesses like Snap and Twitter, where rather than fade modesty, growth slowed dramatically," Swinburne said.

All told, Swinburne is targeting $110 per share for Roku's stock. That's up from his previous price target of $100, but it signifies potential downside of nearly 20% from where Roku's shares are currently trading.

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Joe Tenebruso has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Roku and Twitter. The Motley Fool recommends Comcast. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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