With shares of Roku (ROKU -0.28%) down more than 63% year-to-date, it hasn't been easy to be a Roku investor. The pain will likely continue this year, as management expects just 3% year-over-year revenue growth in Q3 as it battles macroeconomic headwinds that are choking ad spending.
While the short term doesn't look too hot for Roku, what does the long term have in store for the company? Two Motley Fool contributors break down the bull and the bear cases for Roku to find out whether or not investors should own this leading streaming platform for the long haul.
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Bull case: Roku is the leader in a fast-growing industry
Jamie Louko: Roku has undoubtedly had its hardships this year. As macroeconomic headwinds shrink business budgets, advertising is often one of the easiest ways to cut costs. Considering roughly 88% of Roku's Q2 revenue came from digital advertising and subscription and transaction revenue sharing agreements, a decline in advertising demand would hurt the company's top line. As a result, revenue only grew 18% year-over-year for the streaming platform in Q2.
That said, there are reasons to be optimistic about Roku if your time horizon is five years or longer. While the short term might be painful, Roku could benefit from the rising popularity of streaming over the long haul. Currently, roughly 52.4% of U.S. households still watch legacy pay TV. However, by 2026, that's expected to decline to 42.4%, and it should continue to drop as time goes on.
Conversely, streaming is gaining steam. According to Nielsen, adults in the U.S. aged 18-49 spent over 50% of their TV time on streaming services in Q2 2022, a significant jump from 2019 when it was only 30%. Despite this rise in streaming, advertisers are expected to allocate only 22% of their TV ad budgets toward streaming in 2022. If these converge and advertisers begin to shift ad budgets to where consumers watch their TV, Roku could see a bounce back in advertising spending on its platform.
Considering it is the largest streaming platform in the U.S., Canada, and Mexico in terms of hours streamed on its platform, Roku could even see an outsized bounce back. Advertisers will likely buy inventory on the platform with the highest engagement. As the leader with 63 million active accounts and almost 21 billion hours streamed on the platform in Q2, Roku could be that platform.
Roku has the tailwinds pushing it forward and the advantages that could allow it to capitalize over the long haul. Considering the company isn't optimized for profitability but is instead looking to gain prevalence and market share, the company's price-to-sales ratio is the best way to value this business. On that front, shares look attractive: They currently trade at 3.8 times sales -- the lowest valuation since 2017. At this historically low price, it looks like a great time to buy a few shares of Roku.
The bear case for Roku
Parkev Tatevosian: My bear case for Roku centers on its expensive valuation. It includes the near-term headwinds caused by supply chain disruptions, while acknowledging the solid secular tailwind from consumers streaming more content. Even though Roku's stock is down considerably off its highs, it is still trading at a price-to-free-cash-flow ratio of 67 and a price-to-earnings ratio of 89. Relatively speaking, these are near the lowest prices that investors have been able to buy Roku stock. In absolute terms, however, it's a hefty price to pay for a business facing powerful headwinds in the near term.
ROKU Price to Free Cash Flow data by YCharts
The coronavirus pandemic has snarled supply chains worldwide, raising prices for everything from materials to labor. Most businesses have chosen to pass the higher costs to consumers -- but not Roku. Management has decided to absorb the higher costs so customers can access its products at lower prices. As a result, Roku's player segment has generated a gross profit loss for five consecutive quarters. The trend is worsening, too, as its loss of $22 million in the second quarter was more than triple the loss of $6.7 million in the same quarter last year.
Up to this point, Roku has made up for the loss in its player segment with gross profits from its platform segment. However, management has forecasted an end to that benefit in the upcoming quarter. Roku earned an overall gross profit of $364 million in Q3 of 2021. The forecast for this year's Q3 is $325 million in gross profit. It's difficult to justify such a premium valuation for a business with declining profits.
Whether you should buy Roku depends on your risk tolerance and time horizon. If you plan to hold Roku in a diversified portfolio for the long haul, Roku might be suitable for you. That said, this stock isn't for everybody. It could take multiple years for Roku to benefit from the long-term tailwinds, so short-term investors might want to watch this stock from the sidelines.
