There's never a good time for an analyst downgrade when it's a stock you own, but even with that bias it's hard to see the logic in Wells Fargo analyst Steven Cahall downgrading shares of Roku (ROKU -0.82%) on Friday. Cahall is lowering his rating on the streaming video pioneer from a bullish overweight to a neutral equal weight, arguing that the upside potential is limited at its current valuation.

Cahall argues that average revenue per user (ARPU) expectations have already risen 50% over the past year. Roku would have to not just beat expectations but trounce the already high projections out there to keep the party going. 

Valuation calls are cool and commendable, but what party is Cahall talking about crashing here, exactly? Roku shares are roughly where they were when the year began, up a mere 0.7% in 2021 through Thursday's close. He's also slashing his price target on the shares from $488 to $350, so it's more as if his valuation expectations have been revised than anything that the market is doing. The downgrade doesn't add up.

A pair of TV viewers watching something scary from their living room couch.

Image source: Getty Images.

Rocking the Roku roller coaster

No stock is perfect, and naturally Roku has its flaws. Its latest quarter wasn't exactly a crowd pleaser. The quarter itself was solid. Revenue increased 81% for the three months ending in June, with platform revenue soaring 117%. Active accounts have risen 28% over the past year, and ARPU is up a hearty 46%. 

The problem here is that streaming hours dipped sequentially for the springtime quarter as we spent less time in our living rooms cradling the Roku remote and more time connecting in real life after being inoculated with syringes full of freedom juice. It also didn't help that Roku warned that margins would be coming under pressure until at least early next year as a result of supply chain constraints and cost increases. 

Near-term margin hiccup aside, there is still a lot to like here. A lot of ad-leaning companies are seeing ARPU move higher now given the easy comparisons to a year earlier when advertisers were sitting out the first few months of the pandemic. This isn't the case at Roku. ARPU actually rose 18% at Roku in the second quarter of last year, as connected TV advertising kept growing through the pandemic.

Advertisers knew exactly where they had to go if they wanted to reach consumers during the shelter-in-place phase of the pandemic, and a flurry of new streaming services were willing to pay up to be noticed among the thousands of apps available on Roku. APRU has actually soared 73% over the past two years.  

ARPU growth may decelerate at this point, but Roku should continue to gain market share in an already expanding ad market. It has made savvy investments in original content over the past year, a move that not only makes the platform stickier but also makes sure that it has more control of the ad revenue-generating experience along the way. 

Not all streaming service stocks are the same, but slashing Roku's price target by 29% doesn't seem fair. It has thrived competing against some of market's most valuable tech and media companies. It's the brand that 55.1 million active accounts -- and growing -- trust to power the TV streaming experience. Downgrading the stock on valuation when Roku shares are sorely trailing the market this year is not the right call.