(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his clients own shares of NFLX and GOOGL.)

Roku Inc. (ROKU) shares have tumbled by roughly 16.5 percent since November 27 and may be headed even lower based on the company's valuation. Roku shares are currently trading around 4.4 times 2019 sales estimates, a lofty valuation for a company that has no original content and depends on advertising sales to drive growth. 

Given Roku's reliance on Netflix Inc. (NFLX) for attracting new users to its streaming media and its positioning within the online world of advertising, and no original content, Roku should trade at a 30 to 50 percent discount to Netflix and Alphabet Inc. (GOOGL) following the Apple Inc. (AAPL) supply chain model.

Additionally, there is a risk that that once early adoption of its streaming device slows, there will be erosion in sales for Roku's streaming media business, which presently accounts for nearly 53 percent of its $125 million in revenue for the third quarter.

At a discount of 30 percent, Roku would trade at a valuation of a forward price-to-sale multiple of about 3, valuing the company at roughly $2.6 billion. That's a 30 percent decline from today's value of $3.8 billion. 

ROKU Chart

ROKU data by YCharts

Heavy Reliance On Netflix

As Investopedia previously noted, Netflix accounts for a very large portion of Roku's streaming hours, and is the Roku's largest content provider. But Roku does not make any money from Netflix, nor does expect to in the future. Yet Roku trades at a sales multiple of 4.4 times 2019 forward estimates – the same level as Netflix. (See more: Why Roku's Rocketing Stock May Flame Out.)

Given its heavy reliance on Netflix, the situation doesn't seem much different than Apple and its suppliers. For example, stocks Like Broadcom Ltd. (AVGO) and Qualcomm Inc. (QCOM) trade at a premium to the more heavily-reliant chip companies like Qorvo Inc. (QRVO) and Cirrus Logic Inc. (CRUS). 

QCOM PE Ratio (Forward 1y) Chart

QCOM PE Ratio (Forward 1y) data by YCharts

Discount Multiple

Roku is expected to grow revenue by nearly 30 percent in 2019 to $858 million, giving the company with a market cap of $3.8 billion a 2019 forward sales multiple of about 4.4. Meanwhile, Netflix is expected to grow its revenue in 2019 by roughly 20 percent to $17.98 billion, valuing the company with a $80 billion market cap at 4.4 times 2019 sales. 

If this seems off, it should. Netflix deserves a premium valuation because it is the premier brand when it comes to online content, while Roku is merely one way out of many to access streaming content. Netflix creates content and has a recurring subscription model that generates a future stream of revenue. In contrast, Roku sells a device as a one-time purchase and is reliant on advertising to drive revenue growth thereafter. 

Fundamental Chart Chart

Fundamental Chart data by YCharts

Not Google

The expected revenue ad growth is impressive at Roku should it develop, but it is only a fraction of what Alphabet generates, and therefore is not deserving of a premium valuation. Alphabet, which generated 87 percent of its $27.7 billion in ad revenue in the third quarter of 2017, trades at a 2019 forward sales estimate of 4.7 times. 

Roku's rise has been impressive, but one that still has more downside risk, even from current levels. 

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdingsInformation presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.

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