Why Roku Shares Could Bite Investors Hard in 2018

Roku Inc. (NASDAQ: ROKU) was a phenomenal initial public offering (IPO) in 2017. After initially selling 15.66 million shares at $14.00 per share, Roku shares vaulted higher. In fact, this stock may have been one of the great stories for all IPO investors in the last year or so after several other key IPO disappointments were seen elsewhere. What if all the good news, and then some, has already been seen out of Roku for investors?

After closing out 2017 at $51.78, Roku shares were up more than 150% from the prices investors were buying the stock for in late October. And Roku even hit a high of $58.80 on December 19, with a closing all-time high share price of $56.58.

Now those same bull-riding investors have to wonder if all the good news has already been priced into Roku. Some recent analyst calls into the start of 2018 indicate that Roku may still be a great company, but the undertone and actual ratings may have quickly turned Roku into one of the most grossly overvalued stocks for investors.

24/7 Wall St. just featured eight stocks that analysts want you to sell in a strong bull market. Roku could have been in those, but this really needed its own deeper coverage.

Roku shares closed on Friday, January 12, at $43.38 for the lowest closing price in over a month. That is a year-to-date drop of more than 16% at a time when the Nasdaq, Dow and S&P 500 have hit all-time highs almost every single trading day so far in the new year.

Roku’s market cap is currently about $4.2 billion and some of the key analysts believe that is just too high against the 2017 estimate of $507 million in revenue. The consensus estimates are for sales to grow to $661.5 million in 2018 and then to almost $863 million in 2019. Roku does not generate actual income yet, and Thomson Reuters is calling for Roku to post operating losses for 2018 and 2019.

Roku’s strong earnings report for its first actual earnings report as a public company helped jump-start the stock to much higher levels. The streaming television and content service blew past analyst expectations with its third-quarter report in early November with $124.8 million in revenues versus the $110.5 million consensus analyst estimates. Roku’s similar quarter sales a year earlier, before it was public, was roughly $89 million. One problem here is that much of that was deemed to be promotional and perhaps unsustainable ahead.

We now already have at least the beginnings of a vector for how Roku’s growth looked in the fourth quarter of 2017. Roku announced in the first days of January that its active accounts exceeded 19 million at the end of 2017. While that is over 40% growth it was a disappointment to at least some analysts.

Two key analyst downgrades have been seen on Roku so far in 2018, but some other cautionary points have been made as well.

On January 4, 2018, Morgan Stanley downgraded Roku to Underweight from Equal Weight. The firm’s target is now just $30, but that is actually up from an older target price of $25. Still, it was versus a prior $55.44 share price at the time. The dependence upon Netflix and YouTube were both mentioned, and the firm’s call worries that Roku will have to negotiate for a greater share from its content partners. Of the 5,000 Roku channels available, the top 5 channels are also said to represent 70% of the time spent. What was interesting here is that it was just in the prior days before the call that Morgan Stanley had reported a 5.1% passive stake in Roku based on a mid-December SEC filing.

Citigroup lowered Roku down to a Sell rating from a prior Neutral rating on January 5, raising its target price to $28 from $27. This was versus a prior $51.24 closing price. Citi also feels that Roku may now be too dependent upon YouTube and Netflix users.

Here is what should stand out about these two key analyst downgrades — Morgan Stanley and Citigroup acted as Roku’s lead bookrunners for the IPO. That means that the two firms most responsible for getting the shares out to the investing community are no longer willing to endorse Roku as a good investment. That makes buying a strong post-IPO stock come with much more scrutiny in what is nothing short of a raging bull market.

And then on January 9, Oppenheimer reiterated its Underperform rating on Roku with a $28 price target. The firm noted that the number of active accounts exceeding 19 million is probably about 2% below the Oppenheimer estimate. The implied account growth of 43% to 45% compared with the firm’s 47% estimate.

Roku only has six analysts following the company at the start of 2018. The consensus analyst target price of $32.80 from Thomson Reuters is harder to consider with such a small pool of analysts following it. Still, that is down over $10 from the current price and $20 lower than where shares were ahead of these big analyst downgrades.

Roku may also not get much benefit from tax reform. After all, companies losing money aren’t exactly all that worried if their tax rate is 35% or 21%.

It is important to keep in mind that the bull market is really rewarding the companies that are growing and exceeding expectations. The bull market is also punishing those companies which are disappointing shareholders. It was clear where Roku stood in 2017, but that clarity also seems to have done a full reverse now that 2018 is underway.

Now investors have some serious decisions to make about where they want to invest in the bull market that is nearly nine years old now. A very weak stock in a very strong market doesn’t sound like a winning combination at this time. Now investors are just going to have to wait and see what Roku’s fourth-quarter earnings will look like when the company reports in early February.

Stay tuned.