When it comes to stock valuations, there's at least some truth to the old saying, "it's all relative." At least in the near term. The market's approach to assigning reasonable price-to-sales and price-to-earnings ratios can change dramatically in a relatively short amount of time, and we've seen this dynamic play out over the last couple years and lead to wide swings for stocks that trade at growth-dependent valuations.
Additionally, companies that saw surging business due to conditions created by the coronavirus pandemic have now seen some of those catalysts weaken substantially, and it's resulted in some precipitous valuation pullbacks for many "pandemic stocks." Let's take a closer look at one industry innovator that's now down 80% from its peak and looks like a great long-term buy at today's prices.
The market has given up on "pandemic stocks"
Roku (ROKU -3.29%) is a leading provider of streaming-television hardware and services. The company got its start making set-top boxes that could be connected to televisions to make them compatible with Netflix and other services, but it quickly expanded into having its streaming hardware placed directly into smart TVs. The company's forefront position in providing streaming tech for smart TVs also allowed it to successfully spearhead its own digital advertising business that's grown at a rapid clip and put up fantastic margins.
Pandemic conditions created soaring streaming viewership, and the surge prompted stellar performance for Roku's business and share price. As with some other companies that were market darlings at the peak of pandemic-related social distancing and shelter-in-place conditions, you probably wouldn't guess that Roku has continued to put up solid business results based how its stock price has been trending.
Roku's active user count rose 17% year over year in the fourth quarter to reach 60.1 million, and average revenue per user (ARPU) jumped 43% to reach $41.03. Momentum on these fronts helped push overall revenue for Q4 up 33% year over year to $865.3 million and capped another year of impressive momentum for the streaming specialist.
What comes next for Roku?
Roku is facing challenging growth comparisons and headwinds from supply chain disruptions and demand shifts leading to lower TV sales, but it still expects to post 35% annual sales growth this year. That represents a significant deceleration compared to its expansion rate in recent years, but it would still be very strong performance -- particularly when viewed in the context of the business's already impressive gross margins and a trend toward improvement on that front.
With a market capitalization of roughly $13.1 billion, Roku is now valued at approximately 3.5 times this year's expected sales. That's an attractive level for a company that's posting stellar gross margins and still has a long runway for sales expansion. The business has been prioritizing increasing revenue over near-term profitability, but it has a clear path to shifting to substantial earnings and delivering big growth down the line.
Use recent market turbulence to invest in this industry leader
Like many other growth stocks, Roku's valuation was recently dinged by a sell-off triggered by Netflix's disappointing first-quarter results. Netflix had previously guided for net subscriber additions of 2.5 million in the period, but it actually wound up losing 200,000 net subscribers, and the results prompted sell-offs for companies that have significant exposure to the streaming video space or otherwise rely on subscription-based business models.
While the Netflix news prompted the market to reweigh the kinds of valuation multiples it's willing to assign to growth stocks, word that the company will likely move forward with an ad-supported streaming video service could also be viewed as a validation of Roku's business model. It's also worth noting that increased competition is one of the main reasons that Netflix is facing subscriber growth challenges, and most of the main competing services are available through Roku's platform.
Evercore ISI analyst Shweta Khajuria recently indicated she thinks that Roku remains significantly under-monetized with ARPU between $40 and $50, and the firm sees the potential for ARPU to triple from that range. The transition of TV ad spending from cable to streaming is still unfolding, and Roku is primed to be a leading beneficiary as it continues to progress.
With the stock down massively from recent highs, investors could score huge wins with shares at current prices.