Streaming company Roku (ROKU 1.88%) recently reported its earnings for the second quarter of 2022, and the stock fell over 20% the next day. Ouch. Understandably, investors might be soul searching, trying to figure out what it means and whether Roku's future is still bright.
I'm not here to sugarcoat; the quarter was rough. However, there's more to like than what Wall Street's reaction would indicate. Here is what the market is missing.
So, why did the stock drop like a rock?
Simply put, Roku fell short almost every which way in Q2. The company's revenue was $764 million for the quarter, $40 million short of Wall Street expectations. The bottom line missed too; GAAP (generally accepted accounting principles) earnings per share (EPS) were minus $0.82, thirteen cents off the mark.
But the company's anemic guidance for Q3 and the entire 2022 year was probably behind the stock's slump. Management guided for just 3% revenue growth in Q3 and completely withdrew full-year guidance due to concerns over the economy.
The speed at which business has deteriorated is putting fear into investors. Management's guidance just the previous quarter was for 35% growth in 2022, and it had guided for 25% growth in Q2; Q1 earnings were in late April, so management already had a month of data to base that guidance on, and they still came in well short, at just 18%.
In other words, business has slowed down so much in the last two months of the quarter that management badly missed their projections and had to scrap their full-year outlook entirely. Yikes.
Why investors shouldn't panic
Context is always helpful and is critical in Roku's case. Roku is facing two significant headwinds in its business. First, inflation is jacking up the costs to build its Roku sticks and other hardware devices.
But instead of passing those extra costs on, Roku is absorbing them to keep its hardware as affordable for consumers as possible. It's still trying to gain eyeballs, acquiring as many new users as possible.
Gross profit margins for the player segment declined a whopping 18 percentage points year over year to minus 24%, which means that Roku is losing $0.24 on every dollar worth of hardware it sells.
Secondly, many advertisers abruptly slowed or stopped their ad spending on Roku's platform during the quarter because of uncertainty around the economy and whether consumers will close their wallets. Roku referred to a survey that indicated almost half of U.S. advertisers slashed their ad spend in Q2.
This sentiment mirrors what companies like Snap and Meta Platforms have discussed within their businesses. It seems that the advertising space is entering a downturn, which isn't Roku's fault, even if it hurts its numbers.
Wall Street is ignoring this good news
It's not all bad. Investors can find clues about how the business is trending over the long term. Account growth stands out as the most positive takeaway from Q2. Accounts grew by 1.8 million, a 14% year-over-year bump, reaching 63.1 million.
Advertising is the long-term core business, so Roku willingly loses money to acquire new accounts. The larger audience you have, the more you'll make from ads. Management highlighted that long-term trends continue pointing toward a secular shift from traditional broadcast TV and cable to streaming platforms, including live sports coming to streaming, and continued shrinkage of U.S. households that pay for legacy TV services.
Roku could put up disappointing numbers over the next few quarters if the economy softens as many believe it's doing. But Roku's long-term story doesn't change if the company is still picking up new accounts. Netflix has lost subscribers for two consecutive quarters, so it's tough sledding out there.
The stock's decline is painful, but a long-term investor who believes in the long-term opportunity Roku has, as well as management's ability to execute on it, could be rewarded when advertising spending eventually comes back around.