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Is Roku Stock a Buy?

By Danny Vena - Updated Apr 18, 2021 at 10:30AM

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The streaming pioneer sits squarely at the intersection of two ongoing paradigm shifts in the world of entertainment.

The past year has been an eventful one for Roku (ROKU 3.92%). In the face of unprecedented and widespread shutdowns and stay-at-home orders, consumers accelerated their adoption of streaming video -- a trend that played to several of Roku's key strengths. Its business gains have pushed the stock up by nearly 300% over the past 12 months.

However, with the end of the pandemic on the horizon, investors are justifiably wondering whether the stock's upward surge has run its course, and whether tougher days could be ahead for the streaming platform. However, even as the recovery gains steam, Roku has several advantages that should keep its growth story intact for years to come.

A connected TV showing viewing options and apps.

Image source: Getty Images.

A common misconception

While Roku is known for the streaming boxes and dongles that bear its name, those are mostly sold at or near cost to expand its growing base of installed devices. This strategy is one of the secrets to the company's success, but it isn't the only way it's growing its ecosystem.

Several years ago, Roku created a cutting-edge operating system (OS) that it licenses to manufacturers of connected TVs. Since the OS was built from the ground up specifically for smart TVs, it doesn't suffer from the types of limitations that plague rival systems that were developed by repurposing mobile device operating systems. The Roku OS is head and shoulders above the competition, and is the top choice of smart TV manufacturers in North America. In fact, Roku is the No. 1 selling smart TV OS on the continent, powering 38% of televisions sold in the U.S. and 31% of those sold in Canada. The company's international expansion has only just begun, so it has another large, untapped opportunity ahead of it.

Roku is now the industry leader, with more than 51.2 million active accounts. To put that number in context, Amazon (AMZN 2.07%) Fire TV closed out 2020 with 50 million viewers. Perhaps more importantly, Roku's growth is accelerating at a time when Amazon's is slowing. Roku's active accounts climbed by 39% year over year, while Amazon's growth decelerated to just 25%. It's a rare company that can go head-to-head with Amazon and come out on top. 

It all "ads" up

Roku derives its revenue from two segments. The player segment consists of its hardware -- the boxes and dongles. Then there's the platform segment, which includes digital advertising, The Roku Channel, and licensing of the aforementioned Roku OS. This segment now accounts for the bulk of the company's fortunes.

With more than 51 million active accounts, Roku has a treasure trove of viewer data to help drive targeted ads on its platform. The potential growth from this segment shouldn't be underestimated. Currently, more than 29% of television viewing occurs on streaming services, but just 3% of TV ad budgets are spent on them. As those advertising dollars migrate to streaming platforms, Roku is positioned to enjoy a windfall.

Two hands touching digital globe showing various consumer advertising touchpoints.

Image source: Getty Images.

That's not all. The company hosts an estimated 10,000 channels on its platform, and it makes money from all of them. When a viewer signs up for a subscription streaming service like Netflix or Disney+, Roku gets a cut of the subscription fees. However, the majority of the streaming channels are ad-supported services, and that's where Roku really profits. The company gets to sell 30% of the ads that appear on the channels streamed on its platform, using the data it collects to target those ads to the appropriate viewers -- and pocketing the revenue.

Roku has other prime real estate for its digital advertising. The company gets all the revenue from ads that appear on its home screen and on The Roku Channel, its own streaming video channel. The company also communicates regularly with its active account holders via email, highlighting services and programming that might be of interest, mining additional revenue from the service providers.

Expanding its advertising ecosystem

While Roku already has an extensive advertising ecosystem, the company recently made several moves to expand it even further. Last month, it acquired Nielsen Holdings' Advanced Video Advertising business, which lets the company digitally replace broadcast television advertising with digital ads of its own. Roku also agreed to integrate Nielsen's rating measurement tools into its platform, which will further increase the accuracy of its targeted advertising.

Just three weeks later, Roku launched an advertising brand studio designed to help marketers think bigger and grow their ads beyond traditional 30-second TV spots. It will create advertiser-commissioned short-form TV programs, develop interactive video ads, and generate other branded content that will appear on The Roku Channel. It's worth noting that viewership for The Roku Channel is growing nearly twice as fast as the company's overall growth. It now reaches roughly 63 million people in the U.S., up more than 100% year over year. This presents the company with yet another lucrative opportunity.

Show me the money

None of this would matter if it didn't lead to greater revenue and higher profits. The company's revenue grew 58% in Q4, and for the second consecutive quarter, Roku turned a profit. Even more importantly, revenue from the platform segment grew 81%, delivering 73% of total sales.

The company's ability to monetize its platform continues to grow, as evidenced by its average revenue per user, which grew 24% year over year. This was driven by strong and growing user engagement. Streaming hours grew 55% to 17 billion, outpacing user growth. This illustrates that existing viewers are spending more time than ever watching video on Roku -- currently, the average is roughly 3.6 hours per active account per day. 

Couple wearing wool socks huddled on the couch watching television or streaming video.

Image source: Getty Images.

The fine print

There's little doubt that 2020 marked a tipping point for streaming video. Each of the major streaming services notched more impressive growth than they otherwise might have as a result of the pandemic. Now, some investors wonder if the nation's pending return to "normal" might put a damper on further streaming adoption. Sure, Roku's growth could slow somewhat, but viewers were cutting the cord and abandoning traditional linear television before COVID-19 reared its ugly head.

There are also concerns about Roku's sticker price. The stock certainly isn't cheap based on traditional valuation metrics, with a price-to-sales ratio of 26 -- when a ratio of between 1 and 2 is usually considered good.

That said, Roku is firmly entrenched at the intersection of two secular trends that will only continue to gain stream -- streaming video and digital advertising. Taken in the context of the company's robust results and its large and growing opportunity, Roku stock remains a solid buy.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Danny Vena owns shares of Amazon, Netflix, Roku, and Walt Disney. The Motley Fool owns shares of and recommends Amazon, Netflix, Roku, and Walt Disney. The Motley Fool recommends the following options: long January 2022 $1920.0 calls on Amazon and short January 2022 $1940.0 calls on Amazon. The Motley Fool has a disclosure policy.

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