Streaming company Roku (ROKU 4.30%) was one of Wall Street's hottest growth stocks during the pandemic. Unfortunately, a decline in spending across the advertising industry has dumped water on Roku's momentum. Growth is grinding to a halt, and investors are dumping the stock like a hot potato.
There's no denying that times are tough today, but that doesn't mean Roku's future isn't still bright. I don't have a crystal ball, but I can show you two big reasons investors should look for Roku to survive the current downturn and thrive over the long term.
1. Why Roku could survive
Roku's problems are coming from two directions right now. On the one hand, inflation is pumping up the cost to manufacture hardware, streaming sticks, and other products it sells. The gross margin on hardware fell by 4.2 percentage points year over year to negative 19.2% in the third quarter. That's the equivalent of spending a dollar to make something and then selling it for $0.81.
So, why doesn't Roku raise prices on its products? Management is still chasing growth and intentionally selling its sticks/players at the lowest prices possible to bring them into Roku's platform, where they can advertise to them through the other side of the business, the platform segment.
That brings up Roku's simultaneous problem of a softening ad-spending environment. There are concerns all over Wall Street about a potential recession, and brands and companies won't spend as much on ads if they don't believe consumers will buy.
Roku's feeling the impact of that, too, as gross margins on the platform revenue declined 9.2 percentage points in the quarter. Additionally, Roku's revenue growth is slowing to a crawl. That means the costs of running the company, typically spread across revenue, are now more concentrated on fewer dollars.
ROKU Revenue (Quarterly YoY Growth) data by YCharts. YOY = year over year.
Profit margins declining everywhere and collapsing revenue growth will, unsurprisingly, create cash losses. Roku's operating losses were $147 million in Q3, down from a profit of $69 million in Q3 2021. Clearly, that's not good. However, you can think of this as a game of survival, and Roku's poised to stick around.
The company's cash balance declined by $127 million in Q3, but Roku still has just over $2 billion in cash. In other words, it could keep struggling and still have enough money to fund the business for several years.
2. Why Roku could thrive
Ideally, Roku's ad business wouldn't be having such a hard time, but it's outside of Roku's control. Digital ads are a long-term growth trend, so Roku and other advertising companies should see a rebound eventually. But Roku can control various aspects of the business, and that's what investors should consider grading Roku on.
For example, Roku's user growth can indicate whether its struggles are genuinely a result of the economy or Roku's product not resonating with consumers. Roku added 2.3 million users in Q3 -- the most since Q4 of 2021, the holiday season in a year with higher consumer sentiment. That's a great sign, as Roku's ad platform will increase in value as it grows because more eyeballs equal more ad dollars.
Investors should consider keeping an eye on ad spending across the industry but focus on Roku's user growth in the quarters ahead. Roku could be nicely positioned for a strong rebound in growth once ad spending rebounds. The additional users could turbo-charge revenue growth as Roku's advertising business recovers.
