On Aug. 8, Pivotal Research analyst Jeffrey Wlodarczak recommended clients sell shares of connected-TV platform company Roku (ROKU 2.94%), according to The Fly. Considering roughly 3.5% of my retirement portfolio is invested in Roku stock, commentary like this catches my eye.
Wlodarczak presents some good reasons to sell Roku. And my shares are down 30% from where I purchased them, making me subconsciously want to cut bait and run as well.
However, despite everything going wrong, investors can't overlook Roku's enormous potential. And ultimately, overlooked positives are why I'm still holding Roku stock for the long haul.
Should I sell Roku stock?
Wlodarczak's argument against Roku mirrors that of many other analysts and can be boiled down into two main components. First, interest rate increases will keep pushing high-valuation stocks down, which includes Roku. Second, the company's revenue growth is slowing, but expenses are increasing rapidly, which could lead to big declines in profits over the next couple of years.
To briefly address the first point, I have no idea what Roku's valuation will be one, five, or 10 years from now. Additionally, I only have an observer's perspective when it comes to interest rates. Therefore, I can't speculate on valuation.
That said, I will point out that Roku trades at nearly its cheapest price-to-sales multiple ever. That could mean this valuation risk from interest rates is already priced in.
ROKU PS Ratio data by YCharts
The second point regarding slowing growth and rising expenses is a far more legitimate concern for Roku shareholders. On July 28, Roku reported financial results for the second quarter of 2022, and it continues a troubling trend. The company is spending more than ever on sales and marketing with increasingly little to show for it.
Roku has spent over $600 million over the past 12 months on sales and marketing. During this time, the company's active accounts are only up 14% year over year.
Some might point out that Roku enjoyed strong growth in 2020 and 2021, fueled by stay-at-home trends from the pandemic. Therefore, it's unreasonable to expect results in 2022 to be as strong by comparison.
On one hand, this argument is fair. On the other hand, if the pandemic pulled growth forward, now is not the time to be spending $600 million to attract new users.
Over long time periods, stocks go up as earnings go up, and vice versa. If Roku's spending continues to outpace revenue growth, earnings will keep going down and the stock will underperform. Therefore, Wlodarczak's point here is well taken.
Here's why I'll hold anyway
Operating losses aside, Roku is amazingly well-positioned for the future, which is why I'm reluctant to sell a single share at this time.
Consider that Roku's average revenue per user (ARPU) on a trailing 12-month basis has increased sequentially every quarter for as far back as the publicly available data goes: the third quarter of 2016. There are two main drivers for this ARPU growth. First, people are watching more content on Roku's platform, giving them more opportunity to be shown ads. But more importantly, ad rates are increasing as advertising budgets shift from TV sources like cable toward connected TV (CTV).
Streaming service Peacock from Comcast's NBCUniversal is a perfect example of the spending shift underway. Up-front ad spending on Peacock more than doubled year over year at its 2022 sales event, surpassing $1 billion. However, monthly active Peacock accounts were only up about 35% year over year as of the second quarter. In other words, ad spending is increasing far faster than subscriber growth, indicative of the spending shift I'm talking about here.
Roku is poised to benefit as ad dollars generally shift to CTV. But Roku could be particularly well-positioned to command attractive ad rates given its progress in delivering measurability. Advertisers have data about their customers. Therefore, they can build campaigns targeting certain demographics, times, and programming to advertise to people that will likely want their products. But advertisers can still be left wondering whether consumers actually bought products after seeing targeted ads.
Roku can increasingly do better than just target viewer cohorts -- its measurability is improving. For example, it's partnered with grocery-store giant Kroger. And the two companies together now have better insight into whether ads directly lead to sales in Kroger stores.
Moreover, with its recent Walmart partnership, Roku users can respond to ads instantaneously by clicking a button to buy products from Walmart. It's still early and consumers might not actually use the feature. But I'm not aware of another CTV company offering these capabilities at this scale.
Roku isn't a flawless company, and I hope management's spending starts yielding intended results. However, its sails are positioned to capture the CTV trend. And I expect this tailwind to gust for years.
