Better Buy: Netflix vs. Roku

More viewers cut the cord last year, and the number of pay-TV households in the United States dropped by 7.5%, according to eMarketer. That trend has translated into big success for companies like Netflix (NFLX -4.04%) and Roku (ROKU -0.96%), and it's made many shareholders rich in the process.

Going forward, both companies should continue to benefit as streaming content replaces linear TV. But which stock stands to benefit more?

Roku: The leading streaming platform

Roku's platform has become increasingly valuable as the number of streaming services has multiplied. By aggregating content from multiple services, Roku simplifies life for consumers, allowing them to access and manage all their streaming services from one location -- that includes both ad-supported products like Walt Disney-controlled Hulu and subscription products like Netflix. This allows Roku to earn revenue in a few different ways.

Image source: Getty Images.

For premium content, Roku takes a cut of all subscription fees paid through its platform, typically 20%. For ad-supported content, Roku charges marketers for use of its OneView ad tech platform, which allows ad buyers to launch campaigns both on and off the Roku platform.

Additionally, the company sells ad inventory from sources like The Roku Channel, helping it further monetize ad-supported content. Finally, Roku makes money by licensing its TV operating system to manufacturers, and through the sale of its streaming devices.

As a key part of its growth strategy, Roku has focused on driving consumer engagement. To that end, it made deals last year that brought WarnerMedia's HBO Max (owned by AT&T) and NBCUniversal's Peacock (owned by Comcast) to its platform, giving subscribers access to series like Game of Thrones and Parks and Recreation, as well as upcoming theatrical releases like The Matrix 4 and The Suicide Squad.

In general, this strategy creates a flywheel that drives monetization: As Roku adds content, more consumers should join, and as more consumers join, marketers should spend more money on Roku's platform. So far, that dynamic has translated into turbocharged growth for Roku.

Data source: Roku SEC filings. CAGR: compound annual growth rate.

Despite past success, 74% of U.S. households with a TV still pay for live services like cable or satellite, according to Leichtman Research Group. As a result, a large portion of marketing budgets are still allocated to traditional TV. But as more users cut the cord in the coming years, those dollars should shift to streaming platforms. And as the most popular streaming platform in the United States, Roku is well-positioned to grow quickly and create value for shareholders.

Netflix: The leading streaming service

In 2007, Netflix pioneered the streaming industry, and it never looked back. Today, the company operates in over 190 countries, and it's still the clear leader. In fact, Netflix has twice as many subscribers as the second most popular streaming service, Disney's recently launched Disney+.

As a part of its growth strategy, Netflix has invested aggressively in acquiring and developing content. In 2020, the company spent $12.5 billion on content assets, which is actually down from $14.6 billion in the prior year. And all that cash has helped Netflix differentiate itself from rivals: Last year, according to Nielsen, Netflix owned nine of the top 10 original streaming series, and all the top 10 acquired streaming series.

There's a saying in the media industry: Content is king. And Netflix certainly wears the crown. The company's investments have paid off in a big way, driving consistently strong subscriber growth. Moreover, Netflix's growing library of engaging content has translated into pricing power. The average monthly revenue per subscriber has trended upward over time, jumping from $10.31 in 2018 to $10.91 in 2020.

The compounding effect of Netflix's expanding user base coupled with increasing subscription fees has translated into strong top-line growth.

Data source: Netflix SEC filings.

North America is Netflix's largest and most profitable market. The company ended the year with 74 million paid memberships in the U.S. and Canada, up 9% from 2019. But Netflix may be nearing saturation in this geography. According to eMarketer, U.S. video subscription revenue will grow only 3.6% in 2021 and 1.7% in 2022.

Going forward, investors should pay attention to Netflix's ability to add new subscribers in other geographies, as well as its ability to raise prices over time. Those two variables are the core drivers of the company's growth.

The verdict

For what it's worth, I like both of these tech companies. Netflix and Roku have claimed the top spot in their respective markets, and both should benefit as cord cutting continues. Even so, I think Roku has the edge here.

In terms of valuation, Roku trades at a pricey 25 times sales, while Netflix trades at a more reasonable 9.8 times sales. But Roku's business is growing faster, which helps justify the discrepancy. Moreover, Roku has positioned itself as an important player in the massive digital ad market, which gives the company (and investors) more upside potential in my opinion.

For instance, U.S. connected TV ad spend was roughly $8.1 billion in 2020, according to eMarketer. That represents only 13% of the $60 billion spent on U.S. TV ads last year. That gives Roku a lot of room to grow, even in the United States.