Popular investment manager Cathie Wood has grown a liking for Roku (ROKU 2.94%) stock. The streaming enabler exploded on the scene at the pandemic's onset, when folks were stuck at home.
The reversal of that trend as economies reopened, along with supply shortages, has crippled Roku's shares. The stock is down 59% year-to-date, which has investors asking whether they should buy the dip. That fall was worse before rumors surfaced that streaming pioneer Netflix (NFLX -0.08%) may be interested in acquiring Roku. Since they are only rumors, let's consider Roku's prospects on its own, without a buyout.
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Roku has excellent long-term prospects.
Despite economic reopening that has depressed demand for in-home entertainment and supply shortages that are hampering its ability to stock shelves with its products, Roku managed to grow revenue by 28% in its first quarter, which ended on April 28. The company runs on the classic razor-and-blades business model, by which one product is sold at a low price or given away to bring a customer into an ecosystem with a recurring revenue stream.
In Roku's case, the hook is its hardware, or content players, which connect to TVs and give people access to the Roku platform. Once customers are on that platform, Roku generates revenue by showing advertisements, connecting folks to third-party streaming services, and selling or renting digital movies and shows. Roku's platform segment, where these recurring sales take place, generated a gross profit margin of 58.7% in the quarter ended in April.
Meanwhile, its player segment has generated a gross profit loss in each of the previous four quarters. Roku is willing to absorb those losses to connect people to the platform segment, where it more than makes up for the cost of acquiring the customer.
ROKU Revenue (Annual) data by YCharts
In 2021, Roku finally reached the scale to achieve profitability on the bottom line, with earnings per share of $1.71. While profits may be pressured in the near term, with inflation raising Roku's customer acquisition costs, the long-run trend is likely to move in a positive direction for Roku. Folks have resoundingly demonstrated that they prefer to stream their content over using cable or satellite connections. Streaming is nearly always more convenient and less expensive than cable. That's helped Roku grow from $320 million in sales in 2015 to $2.7 billion in 2021.
Despite the crash, Roku's stock is still expensive
ROKU PE Ratio data by YCharts
Even after Roku's dramatic price decrease, it's still not cheap. Sure, at a price-to-earnings (P/E) ratio of 95 and price-to-free cash flow ratio of 72, it is relatively inexpensive based on its historical averages on those metrics. However, in absolute terms, that is still an expensive valuation. A P/E of 95 means that at its 2021 earnings level, it would take 95 years for profits to eclipse the purchase price. Supposing Roku doubled its earnings, it would still take 47.5 years at that level for earnings to surpass the purchase price.
Roku has excellent prospects, which is likely to propel revenue and earnings growth for several years more, but the good news is arguably already priced into the stock. Investors can wait for more of a fall before buying the dip in Roku stock. A further price drop may or may not happen, as the stock is getting a boost from the rumor that Netflix might be interested in making an offer to buy the company. Note these rumors have not been substantiated, but speculation among investors is raising the price ahead of a confirmation.
