Top streaming stocks are seeing their share prices fall along with the broader market and/or because of weak earnings results. Netflix (NFLX 1.98%) just reported that it missed subscriber estimates in the fourth quarter and its stock price was down 20% the day after the report's release.
Despite these drops, this isn't the time to run from streaming stocks. Instead, it might be time to start putting together a wish list of your favorites to go bargain hunting.
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The future of TV is streaming. Major TV networks and other top content distributors have launched their own streaming services over the last few years. It's a sign that we're still in the early innings of where this is all going in the coming decades.
I own shares of Netflix and Walt Disney, which I believe are well-positioned to dominate the streaming market with their respective offerings. But it's also important to ask where traditional media advertising will go. Right now, there's one platform that is leading among advertisers that want to get in front of viewers on digital platforms, and that is the leading TV operating system Roku (ROKU -1.59%). Here's why you should keep Roku stock on your wish list.
Near-term speedbumps
Roku is starting to look like a much better value than where it was a year ago. The share price is down 63% over the last year, despite posting revenue growth of 68% year over year through the first nine months of 2021. That has brought its price-to-sales ratio down from 32 at the start of 2021 to 8.5 at the current share price of $156.
The stock started to nosedive after management provided a weak outlook during the third-quarter earnings report. Revenue growth is expected to decelerate to 37% in Q4, down from 51% in Q3. The main issue is macroeconomic: Higher Roku TV prices could force consumers to delay smart TV purchases, and therefore make it more difficult for Roku to acquire new users in the near term. Management expects this to carry over to weak advertising spending, too.
Regardless of the fourth quarter's outcome, these temporary problems don't impact Roku's long-term intrinsic value.
One trend that points to a lucrative future for the business is the growth of average revenue per user (ARPU), which accelerated to a 49% year-over-year growth rate in the third quarter. This is a key metric that measures how well Roku is monetizing its 56 million active accounts. As a reminder, most of Roku's revenue comes from user monetization, including advertising and revenue-sharing agreements with content providers, while less than 15% of its revenue comes from things like Roku TV sticks.
While CEO Anthony Wood noted that "certain advertising verticals could reduce spend" in the fourth quarter due to limited product availability, the recent gains in ARPU are a sign of Roku's strength. Through its OneView ad platform, Roku is proving it has the tools to help advertisers succeed over the long term as TV increasingly goes digital.
A hedge against streaming competition
There is a lot of bad news already reflected in Roku's valuation. At some point, the stock is going to hit bottom and move higher. One reason I expect Roku to deliver strong returns is its superior revenue growth to top streaming services.
Netflix reported a revenue increase of 16% in the third and fourth quarters of 2021. But with so many streaming services launching over the last few years, viewers are flocking to Roku, which aggregates many of these services conveniently on one platform. Roku posted revenue growth above 50% in each quarter through 2021, but even management's lower outlook for the fourth quarter would be stronger than what Netflix just reported.
Most importantly, Roku might be a good streaming stock to own to hedge against intensifying competition between top streaming services. For example, on its Q4 earnings call, Netflix management couldn't rule out that increasing competition in the streaming landscape may have contributed to its weak subscriber results last quarter.
I don't expect Roku to recover quickly from the current macroeconomic issues. The stock could reach lower prices before it hits a bottom. After all, a market sell-off usually brings the strongest companies down with it.
But the strong growth in ARPU that Roku reported for most of 2021 is a sign of what's coming. Roku will benefit from a cycle of growing total streaming hours on its platform, which reached 18 billion in the third quarter. This higher engagement attracts more spending from advertisers, which increases ARPU, and provides Roku more resources to invest in new content to keep viewers coming back.
It's Roku's strong business model that will keep the stock on my list of potential buys during the market sell-off.
