Roku, Inc. Stock Soars on Specious Netflix Comparison

Roku (NASDAQ: ROKU) had a pretty great Cyber Monday, although it had nothing to do with shopping. Shares booked gains of 18% today thanks in large part to a bullish analyst note. Needham analyst Laura Martin nearly doubled her price target on Roku, from $28 to $50, while maintaining a buy rating.

Martin cites Roku's valuation, strategic position, active account growth, monetization gains, and growing moat as the basis for the price-target boost. It's absolutely true that Roku is executing incredibly well right now in its ongoing transition to becoming a platform company, with active accounts and average revenue per user (ARPU) all marching higher, but there's a pretty glaring hole in the analyst's rationale: a specious comparison to Netflix (NASDAQ: NFLX).

The Netflix comparison falls short

Netflix has been the greatest beneficiary of cord-cutting and the rise of over-the-top (OTT) streaming services. Netflix is effectively the poster child for OTT services. Martin considers Roku to be a pure-play on OTT, much like Netflix is. However, both companies being pure plays on OTT is where the comparison should end, as they are vastly different companies in terms of their business models, operations, and strategies.

Roku doesn't own any of the content it distributes, which Martin considers a benefit because it precludes the risk that any of that content will flop, wasting the money that was invested in creating it. As other content providers and tech giants continue to explore creating their own streaming services beyond Netflix (most notably Disney), that content could potentially bolster Roku's platform if those other parties choose to bring their services to Roku.

Netflix is the dominant streaming service that is increasingly focused on original content, while Roku is a neutral third-party platform focused on content distribution. It's also worth remembering that Netflix represents about a third of all hours streamed on Roku, and Netflix's contribution to Roku's top line is "not material" and is not expected to be material "for the foreseeable future." When gauging the success of Roku's platform, investors should effectively back out Netflix's sizable proportion of hours streamed, as those hours don't contribute to the business in any meaningful way.

The valuation argument subsequently falls short

Acknowledging the dramatic differences between Roku and Netflix is important because then Martin's valuation argument falls apart. Roku shares are incredibly expensive right now for a company that still relies heavily on hardware sales. Those valuation multiples are somewhat justified by the aforementioned emphasis on the platform business, but it's still untenable to consider Roku cheap at 10.4 times sales. The only way to justify that notion is by comparing Roku's valuation to Netflix's valuation, which is even loftier by some (but not all) measures.

If you don't think Roku should be directly compared to Netflix, then Roku shares still look awfully expensive and are pricing in flawless execution in growing the profitable platform business. Roku is undoubtedly executing well, but investors shouldn't assume it won't make mistakes along the way.

10 stocks we like better than Roku, IncWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Roku, Inc wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of November 6, 2017

Evan Niu, CFA owns shares of Netflix and DIS. The Motley Fool owns shares of and recommends Netflix and DIS. The Motley Fool has a disclosure policy.