In 2020, it seemed Cathie Wood could do no wrong. Her flagship ARK Innovation (ARKK -0.47%) ETF soared 149%, making her the toast of Wall Street. Oh, how the mighty have fallen. Since those heady days, the fund has fallen on hard times, shedding 80% of its value last year. Wood is unapologetic, sticking to her guns and investing in the most innovative and disruptive companies she can find. She argues that previous financial crises have resulted in tremendous opportunities for investors who kept their heads.
One stock that Wood is particularly bullish on is Roku (ROKU 0.95%). The stock is a top five holding in the fund, representing nearly 7% of the portfolio. Wood has a target price of $605 by 2026, suggesting upside of more than 1,200% for investors. Wood's bull case on Roku is even more optimistic, with a price target of $1,493, or potential gains of 3,100%.
Will Roku shrug off the current economic headwinds that have buffeted its stock to achieve Wood's audacious goals? Let's look at the big picture.
Image source: Getty Images.
The 800-pound gorilla in the room
Wood and her team at ARK Investment Management issued their research on Roku in mid-2022, before the full extent of the current economic challenges was evident. In fact, since the report was issued on July 7, 2022, Roku stock has fallen 51%.
At the time, Wood's research suggested that Roku stock could achieve a compound annual growth rate (CAGR) of 53% over the coming five years. The stock ended 2022 at less than $41 per share, so even if it achieved that growth rate, the stock price will only reach $223 by 2026. This alone suggests that these price targets may no longer be appropriate.
Perhaps more importantly, Roku continues to face a host of economic headwinds that have yet to ease. The company continues to work through supply chain issues that left its Roku-branded TVs and set-top boxes in short supply. This in turn has stunted its active account growth, which climbed just 16% year over year in the fourth quarter. Equally concerning is the current profit picture. Roku has generated losses in each of the first three quarters of 2022, and that isn't expected to change when the company releases its fourth-quarter results.
These issues will continue to hold Roku back, making it increasingly less likely that the stock will achieve Wood's bullish price targets -- but that doesn't mean the stock isn't a buy.
The nuts and bolts
Digging into Roku's results helps explain the company's subpar performance in 2022.
First, supply chain disruptions not only decreased the availability of connected TVs featuring the Roku operating system, but also increased the prices of the available supply, at least partially thanks to inflation. Roku was not alone in this, as it is a well-documented industrywide challenge. Once the supply chain is flowing freely and prices return to normal, demand for Roku TVs -- and Roku accounts -- will likely improve.
Second, Roku has been hammered by the ongoing cuts to marketing budgets, as it makes the lion's share of its revenue from the advertising that appears on its platform. In the event of a downturn, companies begin scrambling to preserve precious capital, and ad spending is something that's easy to dial down and back up on short notice. Need proof? Simply look at the third-quarter results of the world's largest digital advertisers. Alphabet's revenue grew by a tepid 6% year over year, while Meta Platforms' revenue declined 4%. This illustrates that this too is an industrywide phenomenon, one which will right itself once the economic uncertainty abates.
Yet, even in the face of these challenges, Roku grew revenue 12% year over year in the third quarter, far outpacing its two larger rivals.
Driving future growth
The evidence is clear that cord-cutting continues. During the first nine months of 2022, the major pay-
TV services lost 4.6 million cable subscribers, and total losses for the year are expected to break the record set in 2020, according to data provided by Leichtman Research Group.
That's not all. Last year, streaming video viewing surpassed cable for the first time, making it the principal entertainment venue of the living room. Streaming represented more than 38% of all television viewing in November -- a new all-time high -- surpassing 31.8% for cable and 25.7% for broadcast television, according to Nielsen. Furthermore, streaming video experienced the largest viewing gains, with a 10.2% increase in November.
As viewers ditch cable in favor of streaming video, Roku provides a convenient platform, gathering viewers' streaming preferences into one place. That's what made the company the No. 1 streaming platform in the U.S., Canada, and Mexico in terms of hours streamed. The evidence suggests that once the economy is on even footing, Roku's growth will return. Furthermore, the company recently announced that it will release its own line of Roku-branded TVs. This will bring its operating system into more homes, which in turn will increase its active accounts and the ad revenue it earns -- hastening the day Roku recovers.
One final note. Roku stock is selling for its cheapest valuation ever, with a price-to sales ratio of less than 2. That's not to say the stock couldn't fall further. But if Cathie Wood's estimate is anywhere close to reality, Roku stock is primed to soar.
