It's been a hard couple of years for shareholders of connected-TV platform Roku (ROKU 0.15%). The stock is down 88% from highs reached back in 2021, but it's up 42% year to date, as of this writing. Undoubtedly, some investors are wondering if this is the start of a steady march toward new highs.
As we'll see in this article, there are problems with Roku today. However, there's also good reason to believe this is a comeback candidate, including the company's latest attempt to beat its biggest competitor at its own game.
The bad for Roku
Since the stock price hit its peak, business has actually grown for Roku. Therefore, the entirety of the drop is valuation related. At the peak, it traded at a price-to-sales (P/S) ratio of 33. Now it trades at a P/S of 2.6. In other words, from a valuation perspective, Roku stock is more than 90% cheaper now than it was in 2021 -- the valuation has dropped more than the price.
Investors were once willing to pay a premium for Roku, but not anymore. And there's a simple explanation for this, in my opinion.
Over the last few years, Roku's business has grown tremendously, and that's good. This is what investors were willing to pay up for. Investors hope that greater scale will lead to improved financial performance, but in Roku's case, operating expenses have recently increased faster than revenue.
Some of Roku's expenses are in the form of stock-based compensation -- a real issue but a noncash consideration. Therefore, for the sake of argument, the chart below excludes stock-based compensation to get a better sense of what's happening with the business. But even removing stock-based compensation from the equation presents a less-than-ideal reality for Roku.
| 2020 | 2021 | 2022 | |
|---|---|---|---|
| Revenue | $1.8 billion | $2.8 billion | $3.1 billion |
| YoY growth | 58% | 55% | 13% |
| Operating expenses (excluding stock-based compensation) | $696.7 million | $988.8 million | $1.616 billion |
| YoY growth | 46% | 42% | 63% |
| Operating income (excluding stock-based compensation) | $113.8 million | $422.6 million | ($171 million) |
Source: Roku's filings. YoY = year over year. Parentheses denotes negative number. Chart by author.
Summing this up, Roku's profitability was improving with greater scale. However, revenue growth slowed to a crawl in 2022 while operating expenses skyrocketed, negating years of promising progress. Moreover, its near-term prospects remain muted, but management is calling for 40% year-over-year growth in operating expenses in the first quarter of 2023. So this is an ongoing problem.
The promising glimmer on the horizon
In essence, the numbers are telling us something about Roku's management. Rather than pull back on its investments and enjoy profitability at this stage of its business, management intends to continue to invest aggressively to achieve much greater scale. It's a risky move to forgo profits today in hopes of bigger profits later, but carries the potential for high rewards.
Roku does have one thing going for it: There are 70 million active accounts on its platform, and the company is leveraging that size to its advantage in 2023.
Perhaps the biggest news is Roku's Primetime Reach Guarantee program. The company generates the majority of its revenue through advertising. And it's now guaranteeing advertisers can reach as many viewers as the average program on a top-five cable network -- arguably Roku's biggest competition.
Roku is taking advantage of its big audience with the guarantee, and it comes just before the up-front season for advertisers. That's when advertisers commit significant portions of their budgets for the year, and Roku's promise could boost its market share this year.
Another important thing to watch in 2023 is Roku's retail partner integrations. The company has been signing partnerships to "close the loop" in advertising. Because of partnerships with retail stores and websites, which both have valuable first-party data, Roku can now find direct correlations between ad spend and consumer purchases -- a dream scenario for advertisers. To date, Roku's partnerships include deals with Kroger, Best Buy, and Cox Automotive.
Roku is guaranteeing an audience, and it's measuring the correlation between ads and purchases. These are capabilities that can set Roku apart from competitors. And if they can, then Roku's revenue could dramatically reaccelerate as advertisers commit more of their budgets to the platform and its 70 million active accounts.
Roku is working through problems, but it is a comeback candidate for these reasons. It will report financial results on April 26, which will hopefully give investors better insight into how things are shaping up for 2023.
