With a stock price that's soared more than 140% during the past year and a rich price-to-sales ratio of 21, Roku (ROKU -9.82%) shares leave no room for error. Any negative news could hurt the stock, and that's exactly what happened when the company reported second-quarter results last week.
Revenue of $645 million and earnings per share of $0.52 both beat Wall Street estimates and showed exceptional growth from the year-earlier period. The stock, however, fell 8% on the news and the shares have fallen steadily since then.
Let's figure out what is going on and whether you should consider dumping your shares.
Image source: Getty Images.
Why did the stock drop?
In the latest quarter, Roku users streamed 17.4 billion hours of content, a decline from 18.3 billion in the first quarter of 2021. Investors were disappointed, perhaps because they've become accustomed to the rapid growth the company had when everyone was stuck inside during the early phase of the pandemic.
A significant decline in user engagement is not a good sign for a top streaming stock, though in Roku's case it's not as bad as you might first think. Roku management blamed the fall on "increased out-of-home entertainment activities (such as dining and travel) in Q2 as a result of pent-up demand and the loosening of COVID-19 restrictions." People have clearly been itching to resume the lives they had before the pandemic, possibly overcompensating to make up for lost time. Therefore, expect Roku's engagement figures to continue marching higher over the medium- to long-term.
By comparison, Roku had a solid 19% jump in streaming hours this quarter from the same period last year. And according to Nielsen data, TV viewing hours on streaming platforms overall fell 2%, while traditional TV had a 19% decline during the same time period. This is a clear sign that Roku is still a rapidly growing enterprise. Even while the rest of the TV-viewing market declined year-over-year, Roku grew substantially.
Another possible reason for why the stock fell points to what I believe most people get wrong about Roku: focusing too much on its hardware (or player) business. During the second quarter, this segment accounted for just 17.5% of sales, and this business has represented a declining share of total revenue for some time. And because of "tight component supply conditions and shipping constraints," gross margins in the player business turned negative (5.9%) and the business had a loss in the second quarter because the company didn't pass on price increases to customers.
I'm not worried about this. Roku's bread and butter is its fast-growing streaming business, where the company earns high-margin subscription and advertising fees. Hardware is simply a way for more users to get into Roku's ecosystem. If the business sells its devices at cost or even at a slight loss, there's absolutely nothing wrong with that.
Don't sell this streaming leader
I want to stress that putting too much emphasis on any one quarter is not something long-term investors should do. Instead, it's necessary to take a step back, focus on the bigger picture, and make sure that a company's competitive positioning hasn't weakened. With Roku, I believe things still look superb.
During the latest quarter, Roku added 1.5 million net new active accounts, which was more than the pre-pandemic period in the second quarter of 2019. Average revenue per user (ARPU), a key measure of a subscription-based business's ability to generate sales growth, soared 46%, to $36.46 in the quarter. These numbers show that Roku's fundamentals are strong.
Roku should continue to benefit as the world steadily shifts to streaming. Management has forecast revenue growth of 51% in the third quarter of this year. That's impressive when compared with the same quarter a year earlier, when the company was riding the pandemic lockdown.
Don't panic and don't sell your shares. Roku is well-positioned for many years to come.
