Many companies struggled as economic headwinds drove the Nasdaq Composite into a bear market last year, but ad tech businesses like Roku (ROKU -3.05%) were hit particularly hard. The domino effect started with runaway inflation. Consumer spending slowed as prices soared, so brands cut their ad budgets to compensate for soft demand. That led to dismal financial results for Roku and many peers.
All told, Roku's share price has fallen 87%, but that drawdown also created a buying opportunity for patient investors. Inflation will eventually cool, ad budgets will normalize, and the next bull market will send stocks higher -- and Roku is well positioned to regain its momentum when that day comes.
Here's why.
Roku is the gateway to streaming entertainment
Streaming is undoubtedly the future of home entertainment. Compared to traditional pay television, services like Netflix are more convenient and less costly, and they arguably offer better content. Yet streaming still accounts for a relatively small portion of television viewing time -- no more than 40% in any country, and far less in most. That portends a seismic shift in consumer spending and television ad budgets in the coming years, and Roku is perfectly positioned to benefit.
The Roku platform connects viewers with premium and ad-supported streaming content, creating two monetization opportunities for the company. Roku charges a transaction fee when content is purchased on its platform, and it provides marketers with access to ad inventory and ad tech tools capable of targeting consumers across mobile devices, desktops, and connected televisions (CTV). But the most important thing investors should know is that Roku OS is the only operating system purpose-built for televisions. Competing platforms are powered by modified mobile operating systems.
So what? Purpose-built operating systems typically create a better user experience. In this case, Roku devices suffer fewer video start failures than competing products, and its devices are tied for the lowest buffering rate. That advantage, coupled with its reputation for affordable hardware, has made the Roku brand very popular. In fact, it ranks as the fastest-growing brand (in any category) among Gen Z and millennial consumers. That has propelled the company to the top of the streaming industry.
Roku is the most popular streaming platform in the U.S., Canada, and Mexico as measured by viewing time. In fact, its platform is so dominant in those markets that it actually accounted for more than 30% of streaming time worldwide last year; the next-closest competitor held just 16% market share. And investors have reason to believe Roku can maintain its leadership. Roku OS is the top-selling smart TV operating system in the U.S., Canada, and Mexico, demonstrating the weight its brand carries with consumers.
Roku is chasing a massive market opportunity
According to Omdia, online video ad spending will increase at 14% annually to reach $362 billion by 2027, while revenue from subscription services will increase at 7% annually to reach $118 billion over the same period. Roku is already well positioned to capitalize on that opportunity. Its platform engages viewers more effectively than the competition, and that makes the company a valuable partner to content publishers and advertisers. But Roku is also taking steps to drive adoption, deepen engagement, and expand into new markets.
The Roku Channel: Roku is investing in licensed and original content for its ad-supported service, The Roku Channel, and those investments continued to bear fruit last year. Engagement rose 85% in the fourth quarter, and The Roku Channel once again ranked among the top five channels on the platform in terms of viewing time.
Roku-branded TVs: Roku plans to build its own smart TVs this year. The Roku-branded models will target the higher end of the market, complementing the more affordable smart TV models made by its manufacturing partners. Management believes controlling the hardware and software will drive faster innovation.
Smart home products: Roku recently launched other smart home devices, including cameras and video doorbells. The company will monetize those products with subscription services for cloud storage and artificial intelligence alerts. Management expects smart home services to become a "very large market."
Television-based commerce: Roku has partnerships with Walmart and DoorDash that allow consumers to make purchases directly from ads shown on the platform. Television-based commerce is an innovative strategy that provides advertisers with instant feedback regarding the efficacy of their campaigns, and investors should expect more brands to partner with Roku in the future.
Roku stock trades at a reasonable price
As discussed, Roku reported disappointing financial results last year. Its revenue increased just 13%, and the company posted a GAAP loss of $498 million. That marks a material deterioration from its performance in the prior year, when revenue soared 55% and it posted a profit of $242 million. But temporary economic headwinds are the impetus behind that deterioration, and some investors have become unreasonably bearish about a situation that will ultimately resolve itself.
Shares currently trade at 2.7 times sales, a bargain compared to the three-year average of 13 times sales, and a reasonable price to pay for Roku given its strong position in a growing market. That's why patient investors should buy a few shares of this growth stock today.
