Roku, Shopify: Worth Betting On These Meteoric Small Cap Tech Stocks?

For investors seeking high-octane growth, two small cap technology stocks have proven to be a great bet this year.

Shares of Roku (NASDAQ:ROKU) and Shopify (NYSE:SHOP) have each surged more than 100% in the past 12 months, defying trade tensions, macroeconomic headwinds and the overall volatile trading environment for technology stocks.

Why are investors so keen on these names? And Is there any more upside left after their eye-popping gains?

Roku: Heating Up After 200% Rally

Roku, which went public in 2017, sells devices that allow users to stream video on their televisions. It also sells advertising on the Roku Channel and allows TV networks to sell spots that target specific audiences.

Over the years, Roku has seen explosive growth as a tech platform that’s already preloaded on certain TVs. According to Bloomberg data, 10 of the top 20 selling TVs on Amazon are Roku-connected TVs.

To add depth to its revenue base, Roku also sells ads for its free streaming product called The Roku Channel, which offers a variety of network and other TV shows and entertainment.

Roku has been a volatile stock ever since its market debut in 2017. The price surged more than 40% in the first nine months of 2018, before ending the year down by the same amount. And so far in 2019, Roku has tripled in value, outperforming almost every other technology stock. The stock closed yesterday at $91.37, up 0.9%.

Roku price chart

But after this remarkable rally, some analysts are warning of red flags as competition is about to heat up: tech giants like Apple (NASDAQ:AAPL) and Amazon.com (NASDAQ:AMZN) are targeting the video streaming market, seeking a larger share of the pie.

Analysts calling for caution from Citigroup, Guggenheim Securities and investment bank Stephens flag the recent run and higher valuation, which may make the stock vulnerable to even a slight miss in earnings. On average, analysts are predicting a 14% plunge from Roku’s current market price in the next 12 months.

Shopify: Successfully Riding the E-commerce Wave

Canadian e-commerce platform provider Shopify has persistently proven its critics wrong. The Ottawa-based company, which makes tools that enable mainly small businesses to create websites and engage in commerce across multiple channels, has emerged stronger after every correction during the past 12 months, defying many calls of growth stagnation.

Closing yesterday up 1.5% at $304.54, its shares have surged more than 125% this year, leaving its much bigger rival, Amazon — up just 26% — far behind. Since we wrote about it in March, Shopify stock has gained about 60%.

Shopify price chart

One of Shopify's main strengths is that it offers small- and mediuim-sized businesses a very effective and cost-efficient way of building a secure online store. The platform handles all the hardware security, data backup and payment processing aspects of the business, freeing merchants to focus purely on their core businesses.

The latest catalyst powering Shopify's rally was the announcement in June that it plans to spend $1 billion on a chain of fulfillment centers that would put it in direct competition with Amazon.com.

How much higher can the shares go from here? The average price target among 25 analysts covering the stock is $319 for the next 12 months, about 6% above where it’s currently trading. The stock now trades at around 28 times its trailing sales, making Wall Street analysts nervous about its future direction.

At least five analysts have downgraded the company in the past two months, according to Bloomberg. In almost every case, the lofty stock price was the top concern. “We now see more limited upside to the shares over the next 12 months,” Wedbush analyst Ygal Arounian said in a note last week downgrading the stock to neutral from buy.

Bottom Line

Though both Roku and Shopify have proven they're a great buy for long-term investors, their current valuations don’t make them attractive in the short-run, especially in this late bull-cycle. Investors should pay heed to analysts calls for caution and wait on the sidelines before these stocks become attractive again.

To achieve another leap higher, almost everything has to go right for these names. That, in our view, seems a risky proposition in this market.