Streaming stocks are getting no love on Wall Street right now. For savvy investors that offers the potential for some good deals for those who don't mind delayed gratification.
Roku (ROKU 0.63%) has fallen hardest of all, down 88% from its all-time high. The company has shown continued growth in revenue through the second quarter, as advertisers prioritize ad placements in digital media. But revenue growth is slowing as the advertising market slows with the economy, which has pulled the stock down.
However, one notable value investor still loves the stock. Dorsey Asset Management is an investment firm that focuses on identifying undervalued companies with sustainable competitive advantages and lots of opportunities for profitable growth. One of its top bets is Roku -- the firm doubled its stake in the company to 1.4 million shares last quarter. Roku is also rated a buy by 79% of analysts that cover the stock on Wall Street.
Despite the stock's disastrous year so far, there are two things smart investors understand about Roku's business that doesn't shake their confidence in the company's future.
1. Long-term advertising opportunity is still in play
The best reason to buy and hold Roku stock is the $70 billion worth of advertising that is gradually moving from traditional TV to streaming. Advertising revenue is included in Roku's platform revenue segment, which grew 26% year over year in the second quarter. It made up 88% of Roku's business, while revenue from streaming devices (Roku TV sticks) made up the balance.
|Platform Segment||Q2 2022||Q1 2022||Q4 2021||Q3 2021||Q2 2021|
|Revenue||$673 million||$647 million||$704 million||$583 million||$532 million|
|% of Roku's business||88%||88%||81%||86%||83%|
The growth in platform revenue is all investors need to see to have confidence that the stock will bounce back eventually.
While management expects platform revenue to soften in the near term along with the broader advertising market, Roku reported $1 billion of upfront commitments from advertisers for the upcoming 2022-2023 TV season. A quarter of these advertisers were new commitments that did not participate last year.
The new upfront commitments indicate growing interest by major brands to get in front of Roku's 63 million households, or active accounts. Roku is still on schedule to capture its share of the digital ad market, which means the further the stock falls, the greater it will climb back up when the uncertainty in the economy clears away.
2. Roku can produce a profit
The market has punished Roku for decelerating growth and deteriorating profitability. A year ago, Roku's revenue was growing over 50% year over year, while earning a solid 10% operating margin. In the most recent quarter, total revenue grew 18%, while reporting an operating loss.
However, some of these losses are self-inflicted. Instead of raising prices on Roku TV sticks, for example, the company has kept its prices down amid escalating product costs. The company is trying to keep its devices affordable to grow market share, but the downside of the strategy is lower margins. Management is clearly willing to exchange near-term pain for long-term gain.
Roku is a fundamentally profitable business. It generated over $200 million in free cash flow during 2021. With most of its revenue being generated from advertising and other high-margin transactions, the company can generate around a 10% operating margin or better, as it did last year.
The strong upfront commitments from advertisers and recent growth in the platform segment is why Dorsey Asset Management and other value investors sense a buying opportunity as the stock falls.
The company still posts gains in active accounts, streaming hours, and average revenue per user. These metrics point to growing intrinsic value, even if it's not immediately reflected in the stock price. It gives long-term investors assurance that Roku's business is fundamentally healthy and can emerge from this weak operating environment in better shape to deliver shareholder returns.