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1 Green Flag for Roblox in 2022 and 1 Red Flag

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The popular gaming platform has plenty of growth opportunities, but can Roblox capitalize on them?

Shares of Roblox (RBLX -5.88%) have been hammered over the last three months. The stock price has dropped 30% since its direct listing in March 2021. The stock took another fall last month after a disappointing earnings report.

Roblox management believes it can reach 1 billion users over the long term, so investors probably wonder whether the sell-off is a good time to scoop up a potential bargain.

Before making that decision, let's look at one positive and one negative that highlight the potential opportunities and pitfalls for this growth stock.

Image source: Getty Images.

Green flag: Brands love Roblox

Roblox has come a long way over the last two years. Daily active users have exploded from 19.1 million at the end of 2019 to 49.5 million at the end of 2021. A large user base spending money on virtual currency (Robux) helped drive revenue growth of 83% year over year in the fourth quarter. 

Roblox is just scratching the surface of its revenue potential. It's already generating strong growth from selling virtual currency. However, Roblox still has an enormous opportunity to monetize third-party brand content -- and this leads to a big green flag for the popular gaming platform.

Top brands ranging from NikeVF Corp's Vans, and Kering SA's Gucci have launched their own virtual worlds on Roblox. Last year, Roblox launched 12 partnerships with brands. As Roblox attracts more users, interest in branded content could be a lucrative source of additional revenue.

One day, Roblox may launch the ability to shop goods from these brands within the platform. For example, a user might see a pair of virtual Nike sneakers worn by another player's digital avatar. Roblox could launch a digital shop that allows players to buy the digital version for their own avatar as well as buy the real physical sneaker.

For now, Roblox management believes monetizing these experiences in this way would add too much friction to the playing experience. But ultimately, management sees these third-party brand experiences becoming important economic contributors to the Roblox platform.

Red flag: Decelerating growth

One negative for Roblox is decelerating growth. There was a huge spike in demand when kids had more time to spend at home in 2020, but as kids went back to school last year, growth in hours spent on the platform slowed significantly.

Image source: Roblox.

Roblox reported that users spent 10.8 billion hours on the platform in the fourth quarter. That's an increase of 28% year over year, but slowing growth in time spent is hitting Roblox where it counts. Last quarter, average bookings per user declined 10% year over year.

This trend may just be a short-term speed bump as Roblox laps the tough comparisons to the year-ago quarter's high growth rate, but it still leaves a big question about what Roblox's growth will look like beyond 2022. One analyst at Benchmark has a sell rating on the stock, citing concerns that the pandemic pulled forward demand that may dampen growth opportunities for the foreseeable future.

Is the stock a buy?

Slowing growth puts more focus on Roblox's profitability, where it has reported big losses. The caveat is that Roblox generated $558 million in free cash flow last year, which puts the stock's valuation at 48 times trailing free cash flow.

For a business seeing growth decelerate in the near term, that valuation level might still look high. It depends on where Roblox's revenue growth rate settles beyond 2022, but that's a difficult question to answer right now.

It might be smart to avoid buying the dip and wait to see whether Roblox can reaccelerate its growth before committing. There are plenty of other promising metaverse stocks out there.

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