Here's Why Roku Stock's Valuation Is Getting Attractive

In this Motley Fool Backstage Pass video, recorded on Nov. 29, Motley Fool.com contributors Jon Quast, Jason Hall, and Matt Frankel discuss how Roku (ROKU 0.15%) stock has dropped significantly from its all-time high. One of the factors leading to the stock's drop is competition; investors fear Roku doesn't have a competitive advantage. Shares of the stock were sold off when one of Roku's TV manufacturing partners released hardware that contained software from Alphabet's Google.

Jon Quast: Roku down about 52% from its all-time high earlier this year. It started with second-quarter earnings results. Basically, user growth and user engagement came in below what analysts had hoped to see. That started a downward trend in the stock. There's also fears of increasing competition. Roku provides a streaming-TV platform. You can get all of your streaming-TV channels in one cohesive place on your TV. It enables that. There's other companies that do that as well, including Amazon, including Google, and specifically with Google, one of Roku's main partners, TCL, this is a TV manufacturer. The stock was actually up earlier in the year as TCL expanded some of the TVs that they make with the Roku operating system built natively in. Then Roku stock dropped because they started offering Google TVs as well. Now Google is the built-in, in some of TCLs models here, I believe it is here in the United States. It might have been Europe, I'm not sure which excuse me for that.

Also, there's some fear going on. Much of Roku's revenue is coming from advertising. There is fear that with all the shakeup going on in the advertising world, that their monetization is not going to be as good going forward as it has been in the past. All of these fears are playing in to investors right now when it comes to Roku stock.

I did want to point out though, this is Roku and PayPal. It's like they hit their all-time high, both of them, on the same day earlier this year and have fallen precipitously since. Yes, there are some things that Roku investors seem to be a little bit concerned about. However, since they hit their all-time high, there's a lot of stocks that happened to be down as well, and it's not just Roku, so a lot of things going on here.

One of the things I did want to point out one of the reasons that I really like Roku right now and wanted to go back to July of 2019 just as a way-before-the-pandemic baseline of valuation here. I'm pulling up three valuation metrics. This is your price-to-sales ratio, your price-to-earnings ratio, and your enterprise-value-to-EBITDA ratio. This company wasn't profitable until recently. You can't look at it going back to 2019 on those metrics. On a price-to-sales ratio. If you look back to July 2019, it's basically on par with where it was. Of course, the profitability has increased a lot over the past year. Those valuation metrics, it looks a lot cheaper.

But one of the interesting things about Roku to me, this price-to-sales ratio, I mean, it's in the ballpark of where it was before the pandemic. But something has happened with Roku over this time. This is its gross-profit margin over this time. It has been increasing steadily as its revenue mix goes away from hardware devices which are low margin and in some cases actually at a loss. It's transferring over to software revenue, which comes at a very much more favorable gross-profit margin. This company has, on a structural basis is getting more profitable over time. The valuation is sitting there the same. In a lot of ways these sales, in my opinion, are more valuable. The company, I think in a lot of ways is more cheaper than it was before the pandemic. If you look at the long-term tailwinds here, I think that more people will be streaming TV in the future, not less. If you believe that Roku can hold its own against some of its bigger competitors, I think this a good opportunity today.

Jason Hall: I just struggle with the durability of its competitive advantage. Besides Roku, you've got Amazon, you've got Google, you've got Apple. They have these platform ecosystems. For all of those companies, it just like a feature set of a giant, very well-heeled company. Besides investors, I don't know a single human being that is just a die-hard fan of Roku, the product. I don't know them. Maybe I'm missing out, but that's the thing I finally realized that I've struggled with with the company. I think it's a great feature and it's an interesting product. I just don't see any durable competitive advantage. That's what I struggled with.

Matt Frankel: Its fair. I'm on the same page. I use Roku. I'm a customer. I have I think three Roku TVs in my house. But like Jason said, I don't really know what the secret sauce is. That's where I struggle. I get that it's a good value and it's one that I really liked early on in its publicly traded life and I totally missed the boat on. But its not the only one that I can say that about.