2022 has been a tough year for stocks deemed pandemic winners. A prime example of this is Roku (ROKU -3.05%), one of the leading streaming video platforms. At one point since the start of the pandemic, shares were up over 600% as investors flocked to the opportunity in streaming video, but Roku stock has since taken a tumble, now down 60% year to date. Investors are worried about slowing account growth -- a vital metric for Roku's business -- and supply chain challenges eating away at margins.
So is now the time to buy Roku stock for cheap?
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Solid first-quarter results muddled by supply chain woes
Roku put up solid results recently, but it also faces some concerning trends that need to be addressed. In the first quarter, the company's platform revenue grew 39% year over year to $647 million. That segment now makes up 88% of overall sales and includes advertising, revenue-share agreements, and promotions across Roku's platform. With high gross margins of around 60%, this will be the most important value driver for shareholders over the long term.
While platform revenue is steadily growing, supply chain disruptions and the demand pulled forward during the pandemic are creating two headwinds for Roku's business. First, rising hardware costs caused the player/TV segment to report a negative gross margin of 17.4% last quarter. This is a headwind for Roku's earnings potential and will hopefully resolve itself in the coming quarters. Second, user growth also slowed with only 1.1 million active accounts added quarter on quarter. Roku is not small with 61.3 million active accounts, but investors should still expect this number to grow over time in order for revenue to keep climbing higher.
Large long-term opportunity
The optimism behind Roku stock stems from the long-term tailwind for internet-connected TVs (CTVs) and streaming video. The sector is taking market share from traditional cable video providers every year, and for the first time in early 2022, the reach of streaming TV devices surpassed that of legacy pay TV with 18- to 49-year-old audiences, according to the company. If you believe legacy TV will only continue to dwindle over the next decade, Roku will be able to increase its active accounts and hours streamed on its platform, allowing it to generate more revenue through advertising and its other agreements.
The big worry for Roku is that TV advertising dollars don't migrate to streaming services broadly but to YouTube. Alphabet's video platform is a monster with an estimated 2.6 billion monthly active users around the globe and $6.9 billion in advertising revenue just last quarter. That's more than double Roku's $2.9 billion of revenue in the past year, and YouTube lays claim to the majority of the digital video advertising market.
The video-streaming industry is expected to be worth over $100 billion in a few years, and many of these services will generate revenue through advertising. However, if YouTube continues to gobble up the lion's share of this opportunity, that will be a big challenge for Roku. Though many users access YouTube through Roku's platform, the company does not make any money from the app.
Valuation is tricky
At today's prices, Roku trades at a market cap of about $13 billion. Over the last 12 months, it has generated $1.45 billion in gross profit, which exploded higher during the pandemic. That gives the stock a trailing price-to-gross-profit ratio of 9.3, which is slightly above the market average. The company doesn't make much in net income or free cash flow, but that's because it's still investing heavily for growth.
Data by YCharts.
Two factors should help Roku steadily grow its gross profit. First is the continued tailwind of streaming video and advertising, which we talked about above. But second, the recovery in hardware margins when supply chains normalize should help boost the company's overall profitability. This current drag could well turn into a tailwind over the next two to three years and help gross profit continue its march higher.
Over the long term, investors should expect Roku to turn its gross profit into free cash flow. But for the time being, the stock looks fairly valued based on its trailing gross profit numbers and growth potential.
So is the stock a buy?
Given its growth opportunity and valuation, Roku stock can do well going forward. The only caveat is you must be confident Roku can continue expanding its reach with rising active accounts and streaming hours. If this does not happen and growth stagnates, returns will be subpar.
