Roku (ROKU -10.01%) stock was a big pandemic winner. Shares were up as much as 800% at some points over the last three years as investors got increasingly bullish on the connected TV (CTV) platform's growth prospects. However, that tune has changed in the last year or so. Roku's stock is down around 75% over the last 12 months. The likely culprits are slow account growth and a broad market pullback in growth stocks.
Does this sharp pullback provide an opportunity for investors interested in Roku? Let's see if the stock is a buy right now.
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Q4 results looked solid
The headline numbers for Roku's latest quarterly results looked solid. Overall revenue in the fourth quarter grew 33% year over year to $865.3 million, which is on top of 58% revenue growth in Q4 of 2020. This is a significant slowdown from the prior year, but investors shouldn't be concerned as 2020 got a one-time acceleration in growth due to the pandemic lockdowns.
Moving further into the details of the report, platform revenue (advertising and other non-hardware revenue) grew 49% year over year in Q4 2021 to $704 million. Seeing as this is the majority of Roku's business and the only segment with positive gross margins, this is what investors should be focusing on when evaluating the health of this business. The majority of platform revenue growth has been driven by a 41% growth in average revenue per user (ARPU) over the last 12 months, as Roku builds out its promotion and advertising services.
Even though the report looked solid, Roku stock sold off over 20% the day following the news. Where investors may have gotten concerned is the slowdown in account growth and deteriorating gross margins in the player category. Total accounts hit 60.1 million names in Q4, up 17% year over year, but only up around 5 million from the second quarter of 2021. The player segment, Roku's hardware/TV sales, also sees deteriorating gross margins, hitting a negative 28% in Q4. Roku typically sells these devices at cost, so this isn't a huge concern, but it is currently a headwind as the business tries to navigate supply chain troubles. Investors should look for gross margins to recover back to historical levels of 0% to 10% if/when the supply chain woes abate.
Where can Roku go from here?
The big question Roku investors need to answer is how big this business can get over the next five years and beyond. I see two ways Roku can grow its financials: ARPU and international expansion.
ARPU is a simple story. Roku now has more active accounts than all the cable companies combined in its more mature markets, like the United States. Here, the company likely won't see rapid account growth. However, it can increase ARPU by steadily bringing more advertiser tools to its platform division. For example, in April 2021, the company acquired a dynamic ad insertion (DAI) technology from Nielsen that will allow Roku to offer an end-to-end advertising solution that can replace what traditional TV advertisers use.
It also saw 100% year-over-year growth in streaming hours on the Roku Channel, its own streaming channel that is supported by advertisements. Only 18% of TV advertising is spent on streaming right now, even though it accounts for 45% of TV viewing hours. This mismatch should converge over the next few years, and Roku is the company in the best position to capture that advertising spending.
Internationally, Roku is investing heavily in Latin America and Europe. It has multiple partnerships with TV manufacturers in countries like Mexico, Argentina, and Brazil, replicating the strategy that was so successful in the United States. Success internationally should be measured in the next few years by consistent growth in active accounts.
It is hard, dare I say impossible, to pinpoint exactly how fast Roku will grow its users, revenue, and eventually profits. But if it can consistently grow ARPU and active accounts, it is likely the company can compound its top line by 20%+ over the next few years.
Valuation is much more palatable now
With the stock down so much, Roku's market cap is now at $16.5 billion. That's quite a bit smaller than the $60 billion market value it sported at some points in 2021. With $1.36 billion in gross profit in 2021 (arguably the best metric for valuing Roku's business right now), the stock trades at a price-to-gross-profit (P/GP) ratio of 12. The stock is still more expensive than the market average of 7.2, but it is much more agreeable than when the P/GP ratio was above 40 in 2021.
It is impossible to predict where Roku's stock price will go in the short term. But if the company can keep compounding its gross profit at a 20%+ rate over the next few years and beyond, the stock will likely be much higher five and 10 years from now.
