On July 7, Cathie Wood's Ark Invest published research about connected-TV platform company Roku (ROKU 0.31%), explaining why it believed the stock could reach $605 per share by 2026. This price was based on a series of assumptions Ark Invest has about Roku's underlying business.
On July 28, just three weeks later, Roku announced financial results for the second quarter of 2022, which contradicted Ark Invest's fundamental assumptions. Here's why Roku is unlikely to hit Ark Invest's lofty price target -- and why it doesn't matter for investors today.
Why Roku likely won't hit $605 per share
Over long time periods, a company's stock price is correlated with its business results. This is why Ark Invest based its price target on assumptions about Roku's business. This includes how many active accounts Roku could have by 2026, how much content these accounts will stream, Roku's ad rates, profit margins, and more. In short, Ark Invest published its investment thesis for Roku.
Roku stock crashed and burned after it reported Q2 results because the business deteriorated in key areas. Specifically, the company's gross-profit margin declined from 52.4% in the second quarter last year to just 46.5% now. Total streaming hours declined from last quarter, giving it less opportunity to display ads. And total net revenue was only up 18% year over year -- its slowest growth rate as a public company.
These results from Roku already go against some of Ark Invest's key assumptions when creating its lofty price target. Ark Invest expects Roku's gross margin to expand to 59% by 2026, yet it contracted in Q2. And Ark Invest also expects Roku's revenue to grow at a roughly 39% compound annual growth rate (CAGR) over five years (including this year), even though revenue growth is slowing.
Another thing to consider is Ark Invest's assumed valuation for Roku stock. In its report, Ark Invest says it expects Roku to generate $14.41 billion in revenue in 2026. And it expects its market capitalization to be $93 billion, implying a price-to-sales (P/S) ratio of about 6.5. For perspective, this is nearly double its P/S valuation right now, as the chart shows.
ROKU PS Ratio data by YCharts
Generally speaking, investors should expect valuations for growth stocks like Roku to come down over time as the company matures and growth slows. Therefore, I wouldn't hold my breath for Roku stock's valuation going up over the next 4.5 years -- that's hard to predict. For all of these reasons, Roku stock might not reach $605 per share by 2026.
Here's why Ark Invest's price target doesn't matter
Before Roku shareholders rush for the exits, consider this: Roku doesn't need to hit $605 per share by 2026 to be a life-changing investment. Whether you're thinking of buying Roku stock for the first time or you're already down 50% or more in your Roku investment, the question is the same: Can Roku stock beat the market average from here? For my part, I believe Roku can indeed be a market-beating investment.
Roku stock is down 68% year to date. But I'm unwavering in my belief in Roku's potential due to the underlying trend propelling the business forward. Millions of people are ditching cable and other TV sources in favor of streaming. And with its 63.1 million active accounts, Roku is poised to be a primary beneficiary of the shift.
According to eMarketer data shared by Roku, less than half of U.S. households are expected to use traditional pay-TV sources like cable by next year. In other words, the majority will either have no TV at all or will stream video content. Once the majority of U.S. consumers can be reached via streaming, expect a greater percentage of advertising dollars to pour into the space, to Roku's benefit.
Of course, consumers switching to streaming doesn't automatically mean Roku will be a long-term winner. I'm reminded of former public company AOL (also known as America Online). The company was instrumental in the U.S. internet revolution but eventually lost as new ways to access the internet emerged. It's possible that Roku's platform is instrumental in helping consumers initially cut the cord. But perhaps smart TVs with non-Roku operating systems will eventually steal market share.
That said, ad dollars are flowing toward Roku's platform now. The company just received over $1 billion in up-front commitments -- ad slots purchased ahead of time, a record for Roku.
According to additional data from eMarketer shared by Roku, only 22% of TV ad budgets are directed toward streaming right now. With roughly half of the viewership, streaming could still see outsized monetization gains in coming years. And it's why Roku remains a strong buying opportunity, in my opinion.
