3 Things About Roku That Smart Investors Know

Roku's (ROKU 2.00%) stock has declined nearly 80% after hitting an all-time high of $490.76 per share last July. The streaming device and platform company generated robust growth throughout the pandemic as more people stayed at home and watched streaming videos, but that momentum fizzled out as lockdown measures were relaxed.

As Roku's growth decelerated, it started to struggle with supply chain headwinds -- which throttled its device sales, forced it to absorb the higher costs, and reduced its platform-based ad sales to affected industries. Meanwhile, inflation, rising interest rates, and other macroeconomic threats have sparked a hasty retreat from pricier growth stocks like Roku.

Image source: Getty Images.

Roku failed to address those challenges during its fourth-quarter earnings report on Feb. 17, which disappointed investors with a top-line miss and soft guidance for the first quarter. Roku's stock could remain out of favor this year, but smart investors should focus on these three things instead.

1. It could struggle to expand internationally

Ark Invest's Cathie Wood, who holds Roku as a top holding in her Ark Innovation (ARKK -0.06%) and Ark Next Generation Internet (ARKW 0.03%) exchange-traded funds (ETFs), claims that Roku has a lot of room to grow overseas.

Roku sells its first-party hardware devices in over 20 countries, and it added Germany to that list last year. It also sells Roku OS TVs with third-party partners across six countries, and it launched new Roku TVs in the United Kingdom, Brazil, Mexico, Chile, and Peru over the past year.

That progress sounds promising, but Roku still generates less than 10% of its revenue overseas. Most of its revenue still comes from the United States, where it remains the streaming leader with 38% of the hardware market, according to Parks Associates. Looking overseas, Conviva estimates that Roku controls 37% of the entire North American market but remains far behind other companies across the rest of the world:

Data source: Conviva, Q1 2021.

Roku hasn't established a meaningful presence in Asia yet, and it holds single-digit market shares across the other four regions. Therefore, it could be very difficult for Roku to challenge Samsung, Alphabet's (GOOG 0.66%) (GOOGL 0.62%) Google, and other entrenched leaders as it attempts to reduce its overall dependence on the slower-growth U.S. market.

2. It's mainly a software company

Many consumers recognize Roku as a streaming device maker, but it generated only 17% of its revenue and none of its gross profits from hardware device sales in 2021. The remaining 83% of its revenue and all of its gross profits came from its software platform, Roku OS, which runs on its first-party devices as well as third-party smart TVs.

The bulls argue that Roku OS will remain an appealing option to TV makers that need a smart TV operating system -- but don't want to tether themselves to a tech giant like Google or Amazon.

Roku OS generates most of its revenue from ads and content partnerships. Purchasing ads on Roku's connected TV (CTV) platform might be an appealing alternative to buying ads on "linear TV" platforms like cable and satellite TV -- which are slowly losing users to streaming video services.

Over the long term, Roku could gradually phase out its loss-leading hardware business and live on as a software company.

3. It's carving out a niche in ad-supported videos

To attract more viewers and TV manufacturers to its software platform, Roku is expanding the Roku Channel, its own streaming video service.

Roku acquired a portfolio of more than 75 original shows from the failed streaming platform Quibi a year ago to jump-start those efforts, and it plans to develop 50 more original shows within the next two years.

The Roku Channel already reached households with about 80 million people in the fourth quarter. It might initially seem like Roku is chasing Netflix or Disney in the streaming race, but the Roku Channel isn't a paid service -- it's an ad-supported one.

This makes it more of competitor for Google's YouTube and Comcast's Peacock. If Roku can carve out a niche in this ad-supported streaming space, it could simultaneously widen its moat while expanding its advertising ecosystem onto rival platforms with iOS, Android, and Fire TV apps.

Roku's near-term future still looks dim

Roku isn't down for the count yet. The company still expects its revenue to grow in the "mid-30s" this year even as it faces tough comparisons to the pandemic, ongoing supply chain issues, and competitive headwinds.

That said, Roku's stock could remain out of favor as the market focuses on the macroeconomic challenges instead. Investors should be cautious if they plan to invest in Roku -- and carefully assess its valuations and these three points before deciding if it's a good long-term investment.