There are some incredibly encouraging trends for connected-TV (CTV) platform company Roku (ROKU 1.58%). The company reported financial results for 2022 on Feb. 15, and metrics for active users and engagement have never been better.
Roku ended 2022 with over 70 million active accounts, adding about 10 million new accounts during 2022 alone. This led to a record amount of video content being streamed -- 87.4 billion hours for the year, up almost 20% from 2021.
These positive trends are important context to keep in mind as we talk about Roku's problems. For me, the problems start with Roku's net loss of $498 million in 2022.
Roku's cash-burn problem
For those unaware, I'll review Roku's business model. The company sells devices that allow any TV to connect to the internet for streaming. It also sells additional hardware devices, like speakers. And it licenses its operating software to smart TV manufacturers. The purpose of these businesses is to simply grow its user base -- it's not primarily interested in profits from this part of the business.
Once it attracts users, Roku generates revenue from advertising. But it also makes money in other ways, including when users purchase content through their Roku accounts, when they see a brand-sponsored home screen, and even when Roku users use a remote control that has a dedicated button to particular streaming services. This part of the business is Roku's ultimate money-making opportunity -- not hardware.
In theory, sacrificing profits up front with hardware should lead to faster user growth, resulting in profitable platform-segment revenue for Roku. This part of the investment thesis briefly played out in late 2020 and throughout 2021 before reversing course in 2022, as the chart below shows.
Data by YCharts.
Roku's operating expenses were up 68% year over year in 2022, compared with only 13% revenue growth. This led to the company's largest annual operating loss ever at $531 million. For perspective, its second worst year was in 2019 with an operating loss of $65 million -- 2022 was over eight times worse.
To be fair, research and development expenses and sales and marketing expenses are important for staying ahead of competition and growing a business. Therefore, one might find a silver lining in Roku's spending. In 2022, spending on research and development was up 71% year over year, and spending on sales and marketing was up 84%.
However, operating expenses are up sharply nonetheless. And 18% of Roku's operating expenses in 2022 were in the form of stock-based compensation, which has grown the company's share count steadily over the past five years.
If you're looking for a primary reason why Roku stock is losing to the stock market average over the past five years, consider that its share count is up 39% over this time span -- shares purchased five years ago represent a significantly smaller percentage of the business today.
Data by YCharts.
Roku's path to profits in 2024
To be a little more positive, Roku's management says that it's aiming for profits in 2024. But there's a caveat to its goal. The company isn't shooting for positive operating income, but rather positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). You can call this the lowest profitability hurdle there is, considering how much it adjusts for.
For the record, Roku expects operating expenses to go up more in 2023 and perhaps even 2024 as well. However, it expects the speed at which operating expenses are going up to slow down. And it expects to overcome higher overall operating expenses with much higher revenue.
As a shareholder, I personally believe Roku should be spending to grow its business to an extent. After all, CTV is a big, valuable opportunity. However, I thought that at this scale -- it generated $3.1 billion in revenue in 2022 -- the company would already be producing positive bottom-line results.
To be clear, I don't necessarily believe Roku is a stock to sell because it is still growing its user base and engagement is increasing. Moreover, its advertising technology is potentially game-changing. However, by ratcheting up operating expenses to grow more from here, Roku has made itself a riskier investment opportunity -- it's going all-in on market-crushing growth. And now it has to deliver.
Therefore, Roku stock isn't on my list of highest-conviction buys today either. I believe there are stocks with less risk that offer good odds of market-beating performance. But I'll still be holding my shares from here.
