Streaming platform Roku (ROKU 2.94%) has been a rough stock to own for the past 18 months. Shares have fallen 88% from their highs, testing the mettle of even the most convicted shareholders.
Roku's secret sauce is its advertising business, and conditions in the industry aren't good right now. Analysts are steadily cutting their forecasts for United States advertising spending as brands tighten their purse strings in anticipation of a recession.
But knowing the difference between a temporary setback and a death blow can make all the difference in your portfolio. Here is why investors should consider jumping on the Roku train before it leaves the station.
Is it a Roku problem or an industry problem?
Every time Roku reports earnings, it puts three important operating metrics near the top of its shareholder letter. Those are:
- Active accounts -- How many people use Roku devices?
- Streaming hours -- How engaged is the Roku viewer base?
- Average revenue per user -- How much money is Roku making on viewers?
In its first-quarter earnings, Roku's average revenue per user came in at $40.67, a 5% year-over-year decline. That might set off alarm bells in your head -- Roku has reached the limit on how much it can squeeze out of a viewer! Or you could consider that the dip resulted from a challenging economic climate in which there are fewer advertising dollars to go around.
For evidence, look to advertising powerhouse Meta Platforms, which reported in its Q1 earnings that its price per ad declined 17% year over year. Meta overcame that with vast volumes of ads. Roku's user base is in the millions of viewers, not billions like Meta, which makes it harder to make up for a harsh economic environment.
One could argue that Roku's growth will resume as the advertising industry rebounds. Nobody can say when that will happen, so investors must play a waiting game.
Instead, focus on these two metrics
But that doesn't mean we should sit on our hands or put blind faith in Roku. Real growth is happening at the company; you just have to know where to look to find it. Revisit those three operating metrics and look hard at active accounts and streaming hours. Roku's active users grew 17% year over year in Q1 to 71.6 million, and streaming hours rose 20% to 25.1 billion.
This growth reveals two positives:
- Roku's audience is getting bigger, and more eyeballs translate to more advertising revenue.
- Streaming hours outgrew the total audience, signaling that time spent per viewer also increased.
These are healthy underpinnings for an advertising company and further support the theory that Roku's growth will rebound with the advertising market.
Assuming monetization (average revenue per user) also bounces back, Roku's overall growth will resume as ad spending returns to a platform with a bigger and better audience than before. For long-term investors, these metrics seem like the real litmus test of how Roku's business is doing.
The stock is a table-pounding buy
Roku's not profitable yet, so valuing the company on its revenue makes the most sense. Its price-to-sales ratio (P/S) is 2.5, just off its lowest ratio as a public company. Does Roku seem like a business with an all-time poor outlook?
Viewers and viewership are growing at a healthy clip. The company is expanding its ad-supported streaming service, The Roku Channel. It is also broadening its reach internationally and just launched self-branded smart TVs that have gotten strong feedback in the market. The company still has enough cash on the books to fund many quarters of operations, meaning it has time to operate with a long-term mindset while working toward profitability.
ROKU PS Ratio data by YCharts.
Investing is about balancing risk and reward in a business that guarantees nothing. Roku is making progress in the right areas in a tough environment and has time to work through its challenges. That seems like a pretty robust setup for positive outcomes in the future. You could always wait until Roku's an obvious winner, but the most significant gains could be past by then.
