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Is Roku Stock a Buy?

By Leo Sun – Nov 5, 2021 at 10:25AM

Key Points

  • Roku posted strong third-quarter numbers, but its latest guidance disappointed investors.
  • The player business faces ongoing supply chain challenges.
  • The stock’s valuation will remain depressed until the player segment’s gross margin turns flat or positive again.

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The streaming device and platform company faces near-term challenges.

Roku (ROKU 4.43%) stock is down over 8% following the release of the company's third-quarter earnings report on Nov. 3.

Revenue rose 51% year over year to $680.0 million last quarter, but that figure missed the analyst consensus estimate by $3.4 million. Net income surged year over year from $12.9 million to $68.9 million, or $0.48 per share, which easily beat analysts' expectations for just $0.06. Its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) similarly surged 132% to $130.1 million.

But management's guidance spooked the market. For the current quarter, Roku expects revenue to grow 37% at the midpoint of its range, falling short of the consensus forecast for 44% growth, while adjusted EBITDA is set to decline 34% to 43%.

A person watches TV at home.

Image source: Getty Images.

But could Roku's post-earnings decline represent a good buying opportunity? Let's review the good news, the bad news, and its valuation to find out.

First, the good news ...

When Roku posted its second-quarter earnings report in August, some investors were disappointed by its quarter-over-quarter drop in streaming hours, which fell from 18.3 billion to 17.4 billion.

The bears claimed this slowdown, which Roku mainly attributed to reopening trends, indicated the company's growth was peaking. But in the third quarter, Roku's streaming hours grew sequentially to 18.0 billion. Its total number of active accounts and average revenue per user (ARPU) also rose sequentially and year over year:

Metric

Total

Growth (QOQ)

Growth (YOY)

Active accounts

56.4 million

2.4%

22.6%

Streaming hours

18.0 billion

3.4%

21.6%

ARPU (TTM)

$40.10

10.0%

48.5%

Data source: Roku. QOQ = quarter over quarter. YOY = year over year. TTM = trailing 12 months.

These latest results indicate Roku's growth has yet to peak, even as it faces tough post-pandemic comparisons and competition from Amazon, Apple, and Alphabet in the streaming device market.

Roku's gross and adjusted EBITDA margins also improved sequentially and year over year, as the stable gross margin of its platform segment offset the negative gross margin of its player business:

Metric

Q1 2021

Q2 2021

Q3 2021

Platform gross margin

66.9%

64.8%

65.0%

Player gross margin

13.8%

(5.9%)

(15.0%)

Total gross margin

56.9%

52.4%

53.5%

Adjusted EBITDA margin

21.9%

19.0%

19.1%

Data source: Roku.

The platform segment's margin is improving as Roku integrates more ads into its software (which runs on both first-party devices and smart TVs) and expands its ad-supported Roku Channel.

That software expansion offsets the negative gross margin of its player segment, which doesn't have much pricing power in a crowded hardware market that is currently struggling with supply chain challenges, including higher component costs, reduced inventory, and shipping delays.

Now, the bad news ...

Roku's core business looks strong, but its problems are also easy to spot. First, Roku's player revenue declined sequentially and year over year in the third quarter, which partly offset the healthier growth of its platform business:

Period

Q1 2021

Q2 2021

Q3 2021

Platform revenue

$466.5

$532.3

$582.5

YOY change

100.6%

117.4%

82.5%

Player revenue

$107.7

$112.8

$97.4

YOY change

22.1%

1.3%

(26.4%)

Total revenue

$574.2

$645.1

$680.0

YOY change

79.0%

81.2%

50.5%

Data source: Roku. All dollar figures in millions. YOY = year over year.

The player segment's ongoing slowdown, along with its contracting gross margin, puts significant pressure on Roku's platform business -- which is already growing very rapidly -- to scale up even faster.

It also indicates investors shouldn't hastily dismiss Roku's challengers in the hardware market. For example, Amazon's Fire TV software platform for third-party TVs and its new line of first-party Omni TVs, which launched in October, could gradually lure consumers away from Roku devices.

Roku's sluggish player sales during the quarter, which it squarely blamed on supply chain disruptions, caused it to miss analysts' top-line estimates. Management expects that pressure to persist throughout the fourth quarter.

And the company plans to absorb most of those rising logistics and component costs instead of passing them onto its consumers, so the player segment's profitability will likely remain challenged for a few more quarters.

But is Roku stock too expensive?

Roku is still growing rapidly, and it will likely benefit from the death of "linear TV" platforms and Apple's recent privacy changes on iOS, which will both drive more advertisers to connected TV (CTV).

However, some investors might argue the stock is simply too expensive trading at about 200 times forward earnings and 14 times this year's sales. Roku's price-to-earnings ratio certainly looks high, but I'd argue that in terms of sales growth, it isn't that expensive compared to other high-growth tech stocks. The Trade Desk, an ad tech company also poised to profit from the expansion of the CTV market, trades at nearly 30 times this year's sales. However, analysts expect its revenue to rise 40% this year, compared to 60% growth for Roku.

Roku stock has always been volatile, but it still has room to run. Investors can consider accumulating some shares after its 30% slide in the past three months, but they should realize the share price could remain depressed until the player segment overcomes its hurdles.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Leo Sun owns shares of Amazon, Apple, and Roku. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Roku, and The Trade Desk. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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