Roku‘s (NASDAQ: ROKU) stock price has rebounded this year after a sharp decline in 2022. While the shares now trade around $83, which is more than double the price at the beginning of the year, it is still a significant drop from its peak of $490 in 2021.
Investors are more optimistic about Roku’s growth prospects due to the turnaround in the advertising market. Roku generates most of its revenue from advertising and benefits from its growing base of 73 million households using its platform. This bodes well for the company when the ad market improves.
However, it is important for investors to consider the risks to Roku’s business before buying the stock.
Bear case: Dependence on the ad market
Roku generates about 12% of its revenue from device sales, with the majority coming from advertising. In a shaky economy, when consumers are not spending money, businesses are less willing to invest in advertising, which can impact Roku’s revenue. The company has experienced slower revenue growth throughout 2022 as inflation increased and advertisers became more cautious.
Another concern is that Roku has not been consistently profitable. This means that a weak advertising market can hinder the company’s ability to invest in long-term growth initiatives. Roku has already laid off employees in order to reduce operating expenses as profitability deteriorated.
The company reported a net loss of $107 million in the second quarter, with a trailing 12-month net loss of $660 million through Q2.
Investors seeking a digital entertainment company for the long term may consider a subscription-based business like Netflix, which is less vulnerable to economic conditions.
These are some of the reasons why investors may choose not to invest in Roku. However, for long-term investors, the fluctuation in advertising demand presents an opportunity to purchase ad-dependent companies at a low price and potentially earn a significant return when growth rebounds. This aligns with the principles of value investing, and it suggests that Roku may be undervalued at present.
Bull case: Dominance in the connected TV market
Roku holds a dominant position in the connected TV market, surpassing competitors such as Apple TV and Amazon’s Fire TV. According to Pixalate’s measure of open programmatic ads sold by device in North America, Roku commands a 50% market share, followed by Samsung at 21%, Amazon at 13%, and Apple at just 5%.
These numbers reflect Roku’s growing audience reach and its advertising tools, which help ad buyers measure and manage campaigns for optimal returns. Despite the weak advertising market, Roku reported a 16% year-over-year increase in active accounts last quarter, with total streaming hours on its platform growing 21% to 25.1 billion.
Roku is also expanding internationally, as it became the top-selling smart TV operating system in Mexico over the last three quarters. It continues to dominate as the leading TV operating system in the U.S.
Roku’s affordability is an advantage. Its line of TVs targets the value end of the market, offering smart TVs at a price similar to that of an Apple TV streaming device. The Roku Channel, which provides exclusive content for free through an ad-supported model, is a major attraction for viewers and advertisers. The channel accounted for 1.1% of total U.S. viewing time in May for the first time.
These factors indicate that Roku’s revenue growth is likely to accelerate once the economic outlook becomes more favorable for advertisers to invest in these platforms.
Roku’s revenue growth already accelerated to 11% year-over-year in the second quarter. While the stock has doubled year-to-date, its price-to-sales ratio of 3.6 is significantly lower than its average valuation before the pandemic. With the share prices reflecting the near-term headwinds, Roku, as a leading streaming stock, has the potential to outperform the broader market over the next decade once the ad market recovers.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. John Ballard has positions in Amazon.com. The Motley Fool has positions in and recommends Amazon.com, Apple, Netflix, and Roku. The Motley Fool has a disclosure policy.
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