This Is the 1 Tech Stock I Bought in September

Sometimes, the best companies are right in front of you. Unfortunately, it can take a while to see them. That's what happened to me with Roku (ROKU 1.58%): a service I've used for nearly two years, but a stock I only started buying a few months ago.

I've been building a position in the company slowly, and Roku was the only tech stock I bought in September. Here are the reasons I've been buying shares of this streaming TV service, even as the price climbs higher.

Image source: Getty Images.

1. I like the service

This comes from famed investor Peter Lynch's playbook: If you like a product or service, consider if it could be a good investment. Roku came to my attention because of my aging television, which was smart enough to connect online to Netflix but couldn't do anything else. I wanted to watch streaming TV but didn't want to buy a new television. So in 2018, someone bought me a Roku device for Christmas. With its easy-to-use interface, I was streaming a few minutes later (and have watched a shameful amount ever since).  

2. Lots of people like Roku, too

Roku's user base was growing fast long before the pandemic, which had people looking for stay-at-home entertainment. Here's a look at platform growth and viewing hours since 2018.

Data source: Roku quarterly shareholder letters. ARPU = Average revenue per user for the trailing 12 months. 

According to eMarketer research, Roku has about a 47% percent market share of connected TV users in the U.S., roughly 85 million. (Multiple users from a household typically share a single Roku account.) Its closest competitor is Amazon's Fire TV, which was estimated to have about 71 million users.

I think Roku will keep growing as more people cancel subscriptions to cable TV and satellite services. eMarketer projects cable, satellite, and telecom carriers will lose about 6.6 million pay-TV households in 2020: a 7.5% one-year decline (the biggest on record). Those people will be watching somewhere, and Roku's efforts to land them include deals with several TV manufacturers. Walmart's private label brand, ONN, uses Roku TV as its streaming platform. Walmart also sells Roku TVs from Hisense, TCL, RCA, and JVC. 

Deals with manufacturers should help Roku expand internationally, too, which is critical because of the growth potential. Founder and CEO Anthony Wood noted during Roku's second-quarter earnings call in August that international account growth is stronger than in the U.S., where the market is more mature:

The position we built in the U.S., the advantages of the technology and the skills we built in the U.S. is working for us internationally. It's a huge market internationally. It's 1 billion broadband households. They'll all be streaming eventually.

3. I like how it makes money

Roku sells devices for as little as $29.99, but hardware sales aren't what attracted me -- the platform is. It produces revenue in several ways, including subscription fees to premium channels or transaction fees like when a viewer purchases a movie.

The big growth opportunity is advertising revenue. As part of the deal for using its platform, Roku takes a share of a publisher's ad inventory (30% is reportedly the standard cut). Roku then sells that advertising. In the second quarter, businesses were shutting down and cutting ad spending to save money. Despite those headwinds, Roku reported impressive numbers:

• First-time ad clients were up 40% year over year.
• It retained 92% of its customers who spent at least $1 million in the first half of 2019.
• Platform revenue rose 46% year over year and total revenue was up 42%.

The trend toward connected TV could be seen in other earnings reports. The Trade Desk --  an advertising technology company with strong growth prospects -- saw revenue decline 13% year over year in the second quarter, but connected TV spending on its platform bucked the broader revenue trend by rising 40%. 

Connected TV is surging, and Roku's platform produces a virtuous cycle. Content publishers are attracted because of the huge viewership. Viewers are attracted because there's so much content. And advertisers see an increasing amount of inventory available and can leverage user data to target specific audiences.

Roku year-to-date stock performance, data by YCharts.

Why I bought in September

I failed to recognize this stock in 2018 and missed a 337% rise in 2019. But when the pandemic hit, Roku stock was cut in half, and I started a position in early March at $90.77 per share. I bought more in early April ($81.60) and early May ($115.87).

When the company reported strong results on Aug. 5, it gave me more confidence. In early September, Roku was trading for close to the same price as a year earlier -- despite year-over-year revenue growth of more than 40% every quarter. I added to my position at $155.19 per share. While the company's higher expenses and negative free cash flow of $45.8 million in the trailing 12 months are something to watch, I'm comfortable with increased expenses that help attract users and advertisers to fuel long-term growth.

My dollar-cost average has risen from about $85 per share to about $107 as I've built my position. Sometimes it's difficult to keep buying stocks as they go higher, but I think the shares will look like a bargain a few years from now.