It seems that Roku (ROKU 2.94%) stock isn't done declining. The streaming video giant's shares, which were already sharply down in 2022, slumped immediately following its early November earnings report. Wall Street is worried about a tough holiday season ahead as advertising spending slows and consumers spend less on new entertainment devices.
Roku's management team is more focused on the bright long-term future for the business, which is steadily adding users and reporting strong engagement. Those wins might position Roku for an impressive recovery once the advertising market rebounds. But should investors wait for clear evidence of that improvement before buying the stock?
Let's take a closer look.
The main pressures
Investors had concerns about Roku's advertising business, especially after Meta Platforms in late October reported a rare decline in digital ad revenue. Wall Street feared Roku would face similar challenges in the TV content niche.
Those worries turned out to be well founded. Roku said the U.S. ad market shrank by a brutal 38% in the third quarter, compared with a 17% decline in the prior quarter.
This drop was the main factor behind the streaming service's sluggish 15% revenue increase this quarter, which marked a big slowdown from the prior quarter's 26% gain. Worse yet, management in a letter to shareholder said it believes the pullback in ad spending will persist at least into 2023.
The good news
On the bright side, Roku's platform is showing no signs of losing its relevance or its prime market position. The company gained 2.3 million users in Q3 to push its base above 65 million. Engagement growth was solid, with streaming hours rising by 1.1 billion to 21.9 billion. Roku posted an impressive 10% increase in average revenue per user, which has now passed $44 per year.
The company is also making progress upgrading its core streaming service while branching out into new revenue lines. Its brand-new Roku-branded streaming channel nearly doubled its engagement year over year.
And management is excited about its push into smart-home services that allow users to centralize control over cameras and smart speakers.
Big risks ahead
The main problem is that shareholders can't expect to see concrete benefits from this move for at least several quarters. Similarly, it might be just as long before Roku sees a rebound in the advertising industry. In fact, management is projecting declines in its core platform in Q4. It had been growing at a 39% rate as recently as early 2022.
In other words, sales and earnings trends will get worse, and it is difficult to predict when they will recover.
Management is doing the right thing in focusing on what it can change, including improving the platform so that monetization can soar once the advertising market rebounds. It is still investing heavily in remaining a leader in digital entertainment devices, too. However, the latest results have revealed a major weakness in this business.
Roku is working to reduce its dependence on ad sales through things like its smart-home push. But investors might want to watch the stock for signs of success here before aiming to take advantage of the lower price. Roku is still a leader in a growing industry. But its business is too reliant on advertising sales to make it a clear buy right now.
