Roku (ROKU -0.40%) warned a couple of months ago that the second half of this year would be challenging, and unfortunately it was being honest. The video streaming pioneer posted mixed financial results for the third quarter on Wednesday afternoon, and it followed that up with problematic guidance. 

Shares of Roku were already non-participants in this year's rally. The stock was trading 6% lower in 2021 through Wednesday's close. Its year-to-date slide got worse after opening sharply lower on Thursday. 

At least seven analysts would go on to slash their price targets on the stock following the report. One of them -- Justin Patterson at KeyBanc -- has now cut his near-term goal for Roku shares twice this week. He lowered his price target from $490 to $460 on Tuesday, ahead of the report. He's now perched at $430. There's a lot going on at Roku right now, but it doesn't have to end badly. Selling Roku into Thursday's slide could be a big mistake.

Two people watching something scary on TV. Don't worry. There's popcorn.

Image source: Getty Images.

There's nothing good on TV

Revenue rose 51% to $680 million in the third quarter, slightly below Wall Street expectations but dead center of the guidance it provided in early August. The news gets surprisingly better as we work our way down the income statement, as Roku had warned of supply chain constraints and rising input costs on the hardware front.

Gross profit, net income, and adjusted EBITDA landed well ahead of Roku's guidance, and quarterly earnings of $0.48 a share obliterated the $0.09 a share it earned a year earlier and the $0.06 a share that analysts were forecasting. A closer look at how the performance played out should explain the huge bottom-line beat.

Roku's business consists of two segments. It has the high-margin platform revenue -- consisting largely of the ad revenue it receives from its free hub. It also has the low-margin player revenue consisting of the dongles and other devices that it routinely sells below cost to grow its audience. The 51% top-line growth that Roku reported is a tale of two contrasts. Platform revenue soared 82% for the quarter, a combination of a 21% increase in active accounts over the past year stacked on top of a 49% boost in average revenue per user. Player revenue declined 26%, helping out the bottom line since this segment was expected to produce negative margins but also potentially problematic in terms of active account growth.

Roku also skirted another potential pressure point when it comes to viewership. Roku experienced a surprising sequential dip in streaming hours for the second quarter, as vaccinated users spent less time in front of the TV in the springtime. It was able to return to sequential growth this time around. It's not perfect. If you divide the hours streamed by the days in the quarter and active users to arrive at the average daily hours per user -- not a perfectly accurate metric, and one that Roku itself doesn't put out -- you see it flat with the second quarter. However, at least we're not seeing stabilization on that front.    

Quarter Active Roku Users Hours Streamed Days in Quarter Average Daily Hours per User
Q1 2019 29.1 million 8.9 billion 90 3.4
Q2 2019 30.5 million 9.4 billion 91 3.39
Q3 2019 32.3 million 10.3 billion 92 3.47
Q4 2019 36.9 million 11.7 billion 92 3.45
Q1 2020 39.8 million  13.2 billion 91 3.64
Q2 2020 43.0 million 14.6 billion 91 3.73
Q3 2020 46.0 million 14.8 million 92 3.50
Q4 2020 51.2 million 17.0 billion 92 3.61
Q1 2021 53.6 million 18.3 billion 90 3.79
Q2 2021 55.1 million 17.4 billion 91 3.47
Q3 2021 56.4 million 18.0 billion 92 3.47

Data source: Roku quarterly reports.

Guidance is where things really start to fall apart. Roku expects to roughly break even for the holiday quarter with $885 million to $900 million in revenue. Wall Street pros were modeling a lot more on both ends of the report. Top-line growth would decelerate to 37% year-over-year growth. Deceleration isn't a problem. We have seen this happen every time between the third and fourth quarter, as the holiday period finds Roku's overall growth weighed down by slower-growing player revenue. Clearly analysts weren't expecting things to slow down that much. 

Roku remains a bellwether for streaming media stocks, and the stock opening 8% lower on Thursday sounds more like a dinner bell than an alarm. Its platform is growing, and supply chain constraints we're seeing across many industries should prove transitory. The market's dumping Roku this week -- and this year -- but I'm more likely to add to my position than to sell in the near future.