Roku (ROKU 0.06%) stock is trouncing the market so far in 2023, but that rally will soon be tested. The streaming video giant is slated to give investors its first-quarter earnings update in late April, likely sparking volatility for the stock price in the coming days.

Encouraging signs heading into that report include strong engagement momentum on Roku's platform and continued economic growth. Rival Netflix (NFLX -1.35%) also had positive things to say about the advertising market, at least as it relates to the streaming leader's global massive audience.

So, let's look at the prospects for Roku's stock returns from here.

The Q1 update

Investors have some big questions heading into Roku's Wednesday, April 26, report. While its streaming platform gained users and handled more engagement, its finances worsened in 2022. Revenue rose by just 2% in the fourth-quarter period that ran through late December, and operating losses were $238 million compared to a modest gain a year earlier.

Roku's main challenge has been a weak TV advertising market that's ideally on the mend. Netflix recently said its new advertising business is generating impressive economics through early 2023. While this success could be related to the novelty of the program, Roku might also benefit from rising advertising demand. The key metric to watch is average revenue per user, which only grew 2% last year compared to a 44% spike in 2021.

Cutting losses

Roku also needs to cut costs while making its business less reliant on volatile advertising demand trends. We'll get big updates on both initiatives in the Q1 report. The good news is that management is prioritizing this shift toward a more efficient business model. "We plan to continue to improve our operating expense profile to better manage through the challenging macro environment," executives said in a recent shareholder letter .

Roku's own content channel grew quickly in recent quarters, and more success here should help the company better monetize its platform. Roku is offering subscription services for a widening range of smart home appliances, too. Overall, executives projected continued losses in 2023, with a return to profitability likely over the next few fiscal years.

The valuation

Roku's valuation spiked in the past few months, making the stock seem like a riskier investment. You'd have to pay 2.7 times sales for the stock right now, compared to about 1.8 times sales at the start of the year.

Sure, Netflix is much more expensive at 4.5 times sales. But the streaming video leader is on track to generate over $3 billion in free cash flow this year and is targeting a third consecutive year of operating profit margin of around 20% of sales (after adjusting for currency swings).

ROKU Operating Margin (TTM) Chart

ROKU Operating Margin (TTM) data by YCharts.

Roku's comparable metrics are both deeply negative and still trending lower. And management cautioned investors to expect another potentially tough financial year ahead as the ad market slowly recovers.

As a result, investors might want to simply watch this stock from the sidelines until Roku can show a clearer connection between rising engagement on its platform and sustainable profitability.