Roku (ROKU 1.91%) shareholders are trying to forget 2022, when the stock lost a whopping 82% of its value. Rapidly rising interest rates, which can seriously hurt unprofitable growth stocks, deserve some of the blame. Furthermore, a slowdown in the digital ad market became a real headwind for the business.
As of late March, though, the shares are up nearly 60% so far in 2023, easily exceeding the performance of the Nasdaq Composite by a huge margin. Investors might quickly assume that the worst is over for Roku, and that it's now time to load up on the stock at a historically cheap price-to-sales multiple of 2.8.
But there are some key risks that shouldn't be ignored. Let's take a closer look at this streaming service company.
An unprofitable enterprise
Since its initial public offering in September 2017, Roku has only had one full fiscal year, 2021, in which it posted a positive net income. And in 2022, the company posted a net loss of $498 million, its biggest in one year.
To be clear, Roku hasn't consistently produced profits. And in a highly uncertain economic environment, where interest rates could stay higher than they've been for most of the past decade, investors are going to start demanding positive bottom-line figures from the businesses they own.
Looking toward the rest of 2023, Wall Street consensus analyst estimates call for a net loss of $742 million this year, which is greater than the figure in 2022. If there's a prolonged downturn in the digital ad market, can Roku survive without needing to raise extra capital?
Management does expect that Roku can achieve positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2024. However, until the company can get on a path to positive free cash flow, shareholders might want to proceed with caution.
Lack of negotiating leverage
One of Roku's most favorable attributes is the fact that it tries to be an agnostic platform, wanting every streaming service to be offered to its 70 million active accounts. As streaming entertainment continues to chip away at traditional cable and broadcast TV, Roku should stand to benefit as the top gateway for people to consolidate all their subscriptions in one place. The popularity of ad-supported services could also boost Roku's prospects by theoretically giving the company a greater ability to sell slots to marketers.
However, it's not as wonderful a scenario as you might think. Roku was in a spat with Alphabet's YouTube in 2021, finally reaching an agreement in December that year to keep the video-on-demand service on Roku's platform. But what's surprising is that Roku doesn't receive any revenue from YouTube.
And with the recent launch of Netflix's highly anticipated ad-based tier, investors might assume that this could benefit Roku financially. Based on YouTube's partnership with Roku, it's probably unlikely that the latter will receive any ad inventory from Netflix, either. Roku has no negotiating leverage with top content providers. In other words, it needs these services much more than they need Roku.
Competing with the big names
Lastly, Roku is in direct competition with some of the largest and most financially robust companies out there. Yes, Roku does command the top market share among smart-TV operating systems in the U.S., Canada, and Mexico, which can't be understated. It has established a well-recognized brand in the space.
But Roku has to constantly worry about the aforementioned Alphabet, as well as Apple and Amazon. Alphabet is the undisputed leader in digital advertising. Amazon generated $37.7 billion in ad revenue in 2022. And estimates call for Apple to produce $30 billion in ad revenue by 2026.
Then there's the fact that all these businesses have their own streaming services, in addition to their own hardware players that rival Roku's media sticks. If any of these dominant tech behemoths decide to invest more resources toward this market, it could prove to be a scary situation for Roku.
Shareholders should consider these risks before thinking about buying Roku's stock.
