Investors should zoom out and focus on the long term.
Roku (ROKU -0.98%) is another perfect example of a pandemic-era darling that has fallen from grace. Shares skyrocketed 530% from their March 2020 low to their all-time high in July 2021, driven by monster success fueled by consumers spending more time at home.
However, the shares now trade 86% below that peak price. So, is it time to buy the dip on this growth stock?
Riding the streaming wave
Part of the reason Roku’s stock has been under pressure in recent years is because of slowing growth. Revenue jumped more than 55% in both 2020 and 2021. As consumer behavior normalized, those gains weren’t as impressive.
But the situation is not as bad as the stock’s performance would suggest. Roku posted a 14% revenue gain in the latest quarter, with management forecasting an 11% rise in the third quarter. The business is still expanding at a healthy pace.
The company added 2 million active accounts in Q2, bringing the total to 83.6 million. Roku has top-market share among providers of smart-TV operating systems not only in the U.S. but also in Canada and Mexico. And engagement is through the roof, as a whopping 30.1 billion hours of content were streaming in the last three-month period. This means that each account on average spends four hours per day on Roku.
Roku prides itself on being an agnostic platform that plays ball with all the content companies out there. Consequently, the business is in a favorable position to gain from the ongoing cord-cutting trend. Another benefit is that it doesn’t have to shell out billions of dollars each year to license and produce content. As more consumers ditch their cable subscriptions, Roku will undoubtedly be a top choice to aggregate the numerous services out there into a single-user interface.
Investors might not like the cyclicality of the digital-ad industry. In softer economic periods, marketing executives pull back spending. This is exactly what happened in 2022 and 2023. Over the long term, though, it’s inevitable that ad dollars will flow to streaming services because that’s where the eyeballs are. This should play to Roku’s favor.
Risk and valuation
Roku might be the leading-streaming platform. However, the business isn’t without some notable risks that investors should know about.
For starters, the company isn’t generating positive-net income. Management boasts that the business has reported positive-adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in four straight quarters, with the expectation that this will continue going forward. But that figure not only excludes key expenses, but it can be manipulated to make things look good.
The fact that Roku isn’t yet profitable on a generally accepted accounting principles (GAAP) basis means that the business model hasn’t yet proven that it’s financially sustainable.
Roku has grown its revenue, user base, and engagement over the years on the backs of the streaming-secular trend. But by keeping a critical eye on the company’s industry positioning, there is one thing to keep in mind.
A valid argument can be made that Roku is at the mercy of the major content companies. For example, I’d suspect that Netflix or Alphabet‘s YouTube share none or very little ad inventory with Roku. And Roku needs these two businesses to cooperate more than the other way around. This tells me that the content publishers have the negotiating leverage.
Investors need to be aware of these risks. But given that the stock trades at a price-to-sales ratio of 2.6, which is substantially below its historical average of 9.5, the valuation is compelling enough to buy the dip on this growth stock.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Netflix, and Roku. The Motley Fool has a disclosure policy.
