The Real Reason Roku Stock is So Prone to Falling Now

Roku

Morgan Stanley analyst Benjamin Swinburne just downgraded Roku from the equivalent of a hold to a sell, and people are selling. It was not fundamentals that did this though.

Fundamental analysts try to explain everything that happens to a stock with fundamental analysis, which seems natural enough given that this is how they approach understanding the movement of stock prices.

Since stocks trade on markets, there’s a lot more going on than this, and the market takes this fundamental data about the stock, fundamentals related to the economy, stock trends, market trends, forecasts of every type, and anything else that they deem to influence their view of a stock’s outlook, do this on many different time frames, and put it all together to decide where a stock’s price is at and where they think that it is headed.

It’s great to want to simplify things by looking at things like projected earnings over the next year or two to understand price movement, but given that there is real money on the line, oversimplification is not a mistake that we want to be intentionally making. Simpler is better but simple mindedness is not.

This is not to say that views such as a company like Roku expecting to see a slowdown in earnings growth isn’t meaningful, but we also need to look around and see what else may be going on, and some of these other things are important indeed in terms of their influence on a stock’s price near term. The longer-term will arrive in good time but the point of action is always in the present, which is a much more important insight than it may appear to be and needs to be understood.

A good example of looking toward the future but staying in the present is with all the worry people have about the long bull market with stocks ending. We might be concerned about a number of potential threats on the horizon but as long as the road ahead is clear enough, it would be foolish to look to ignore the present in favor of the future when things look fine now. However, these forward concerns can have us more on guard and also help us interpret events that do come our way to decide on the weight we give them by referring to how much risk there is out there in the near future.

Where Roku, either the stock or the company, ends up in 2022 for instance is interesting, but what really matters is where the market thinks it will be in 2022 right now, in December 2019 in this case, because it is this belief and nothing else that influences the effect this has. The market also has opinions with many other timeframes, and it’s foolish to just look at this one as there is so much more going on that will impact a stock’s position in 2022 than just earnings projections out that far.

The price of a stock is nothing more than the sum of future expectations in the present, and all of the future expectations are included in this in addition to everything else that matters. If we want to glimpse this, we won’t learn that from looking at just one piece of the puzzle.

Morgan Stanley analyst Benjamin Swinburne, who just downgraded the stock from equal-weight, the equivalent of a hold, to underweight, the equivalent of a sell, warns us that the future growth of Roku over the next while is already priced in. Of course it is, because that’s what the stock market does, it prices in expectations of future growth. You could say that about any stock in the market actually so this is not really noteworthy.

It might be if we think that the market has blinders on and just focuses on this particular timeframe with fundamentals. This is not how it works, but we need to understand enough to get this. We could just step back though and wonder what sense this could make, but this limited view is so ingrained that all other views are ignored, much like followers of a religion are prone to reject beliefs based upon fit.

We can understand stock outlooks in terms of pieces of a big pie, and the first distinction that we need to make is one of time. There are outlooks that manifest in a stock’s price that range from anywhere from a millionth of a second to several decades, and all of these outlooks exert their influence on price, yielding a real hodgepodge of outlooks.

Some pieces of the pie are bigger than others though, and some may be a lot bigger, like the influence of shorter-term trading has had with this one. When a stock bounces around this much, we need to pay attention to these things if we are at least trying to be wise.

This also breaks down to what we could term external and internal influences, with external influences being the ones aside from the movement of the stock price itself, like company and economic data, as well as internal influences, how the movement of the price itself may influence further price movements, like a stock being under accumulation or distribution where this action itself influences price.

This all might seem like predicting stock prices would be way too daunting, but as long as we focus on what is important, we can get a good handle on where things are going and a good handle is all we can even shoot for. This does provide either a probabilistic advantage or disadvantage depending on the quality of our analysis though, where having probability on our side to some degree is the goal.

Roku is an Outstanding Example of the Sheer Power of Market Behavior

Roku does provide an interesting example of how we want to be approaching this analysis, especially since its behavior is on the more predictable side. We see the price drop by a lot like we saw on Monday, we hear from analysts such as Swinburne telling us the upside is priced in and earnings are expected to slow, and we may think we have it figured out enough to act.

The problem here is that just telling us something we already know doesn’t explain things, as earnings were slowing as well last Friday, and we really don’t have any news since other than this downgrade, and we just gave up 9% in a single day, so this move surely could not be based upon fundamentals.

Swinburne’s perspective just looks at one slice of this pie, and not a very big one at that, and we aren’t going to be measuring very much with such a limited perspective such as this. This takes a limited scope of influencers, the business outlook for next year for instance, and pretends that this is all there is, where factors such as the influence of expectations beyond this as well as the influence of the actions of investors themselves get ignored, which can only provide a limited view. To make this worse, these factors are already known and priced in and citing them does not change anything other than creating fear.

Investors don’t generally restrict themselves to next year and even institutional investors look further out than this even though they may be more than willing to rotate their positions every so often when needed. Many investors may be excited about how Roku may leverage their market share of this market over the next 20 years, and therefore may expect its stock price to be much higher at that point, and therefore may see today’s prices as a bargain.

There’s also the effect of those who take a much shorter-term view, the traders, and traders drive stock prices a lot more than most people realize. Traders don’t ever hold a high percentage of a stock but sure do hold a big percentage of the stock in play.

Looking at charts can in itself provide a very good foundation for understanding price movements, because that’s what charts do, they depict it and tell a story of not only where we’ve been but also speak to where it may be headed, more likely than not that is, which is all we are after and all we may expect.

What we do with these charts depends on our goals, and there just isn’t one chart, as we can view this price data on many different scales. Charts need to be seen as fundamental though, where our forecasts may suggest a certain direction but if we don’t see that happening in real life on the charts, reality always trumps guesses, and guesses based more on reality trump ones that are purely speculative and are based upon a limited scope, like we get from the fundamental analysts.

The very fact that they try to set price targets speaks loudly to their lack of real understanding, as there are just too many things involved to even want to do such a thing. This requires us to try to oversimplify so much that most of the things that will influence the future price are just ignored, like the effect of both market and investor trends, as well as the sheer degree of uncertainty that is out there.

What actually moves prices more than anything these days is the movement of the overall market itself, and this alone has us just guessing if we’re looking to predict what price a stock would be at some point down the road independent of market forces. If we try to qualify this with an all things being equal, this will boil down to excluding all influencers besides the narrow ones we’re looking at, and given the sheer weight of these other influencers, this turns our predictions into guesses.

Simpler is Better, but There is No Substitute for Being Right

Simpler explanations are preferable though, provided that they are both simple and effective. In Roku’s case, this is just all about people taking profits, even though the effect of profit taking is one of the many things that does not make it into the model of fundamental analysts, and isn’t even a fundamental factor at all.

Roku’s journey has been an interesting one, and one that shows a number of points where profits were clearly taken to a large degree. We started with the initial run-up of 350% from its open price, from $15 to $56 in the first 3 months. While many investors would be more than happy to let this ride, traders sure didn’t, and we saw it run back to $32.

We knew that this IPO was a good one already when it stabilized there and started move #2, and this time got to $77. Already, this was a trader’s dream, especially those who shorted it after its first peak and got back in when it bottomed 4 months later. Taking out the original high was particularly bullish.

The next drop didn’t have anything to do with the stock itself, as we now had the October 3-December 24 market decline. If anyone wonders what power the market has, when they see how many stocks followed this trend to the very day on both sides, they will become more enlightened.

Santa Claus brought a much bigger rally than he usually does last Christmas, and Roku was along with the ride along with the majority of stocks and all of the ones worthy of our attention on the long side.

Over the next 9 months, we went from $26 to $169, with all but a tiny bit happening in 2019. Roku was one of the highest-flying stocks in the market over this time, as more and more eager traders and investors piled on.

If you are trading this, you don’t even care if you get on late as you are ready to jump off at any time, and that’s exactly what people did. This over 9-month rise eventually took us to the point where demand dried up enough to allow supply to overtake it in a notable way, and when that happens, you are headed back down the mountain.

All this money on the table not only became too tempting for a lot of traders, but this transition even revealed their exit point, as their strategy was always to sell once the crazy buying stopped enough to indicate a top. Those who had such a plan did get out, and in just three weeks, we went from $169 to $99.

At this point, we could say that the overall view on balance had turned bearish as well, not bearish enough to want to stop riding this horse, but bearish like the original fall of Bitcoin was, once we knew that we probably weren’t going to make it back to the top of the mountain or higher anytime soon.

The next month provided a 50% comeback, and 50% in a month is pretty amazing, especially for a stock that has shown that it is tiring. The excitement about the future was still there, and the traders were still at it as well, and together they pushed this over $150 once again.

We really knew that the volume was being turned down for real when Roku beat earnings expectations and we immediately saw the stock sell off by 16%. This is pure profit taking. This one really speaks to investors, as this was a show of more than just temporary tiredness.

We weren’t done yet though as we ended up rebounding from $118 to $164 in no time. This takes us to the present where we’ve now taken it down to $136 in just 4 trading days, with most of this happening on Monday.

You can’t explain any of this very well with fundamentals, and fundamentals don’t even play on these time frames. Roku has simply been fabulous to trade right from the start, and especially this year. This is not our pricing in the next two years, it is more like a stampede that alternates directions often and runs like mad in both directions, depending on where the herd is pointed, fundamental analysis be damned.

Perhaps ironically, Swinburne himself has participated in this story, as there is little doubt that his downgrade did scare some people and helped precipitate this big one-day loss. There wasn’t anything else going on actually other than Roku already tilting that way last week, but this pushed it over the edge.

This is like the observer influencing what is observed on a quantum level, and the observer had a pretty big effect with this instance.

We’ll have to see where this settles in, but slower earnings forecasts or not, this ball is made of very hard rubber and there may be several more opportunities to watch it bounce for fun and profit.

Monica

Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.