ROKU, a member or our “Top Ten Bubble Stocks (that could drop 50% or more)” list that we published in early October, reported earnings yesterday. Despite beating both top and bottom line earnings estimates, the stock was down a staggering 22% today.
We have talked extensively about “growth options” on this blog. (High Expectations Can Bring Big Risks). Recall that a firm’s equity value can be thought as being comprised of two components: 1) The value of current operations (which includes 5 years of future expected growth) and 2) everything else which is the “growth options”. For tech companies like Roku, the growth options often include distant future opportunities that investors envision.
ROKU’s value is largely based on the 2nd components – the growth options. Companies whose value depends primarily on growth options can be highly sensitive to even a whiff of slowing growth. That was the case with ROKU. Despite the good top and bottom line performance, the earning release foreshadowed slowing user growth. The related decline in the value of the growth options swamped any good news about current operations, sending the stock down 22%. This underscores the need for caution among those considering investment in companies whose value is largely dependent on growth options.