Investors are wise to consider putting money to work behind broad secular themes. Companies that can ride these trends to new heights might also make for solid investment candidates. And the ideas can come easily, simply by paying closer attention to the world around you.
Streaming entertainment fits the category here. And within this, Roku (ROKU 5.41%) looks to be positioned well as the industry grows. Its stock is 87% off its 2021 peak, so investors might be presented with a stellar opportunity today.
Let's take a look at where Roku could be three years from now. For current shareholders, there is definitely sizable upside.
The top TV operating system
At a high level, Roku is a three-sided platform that connects content companies, advertisers, and viewers all in one place. The company exists with the view that over time, as more hours are spent watching streaming TV, as opposed to traditional cable, more ad dollars will shift over as well. According to management, Roku is the top smart-TV operating system in terms of market share in the U.S., Canada, and Mexico.
In the first quarter, Roku had 71.6 million active accounts that streamed 25.1 billion hours of content, key performance indicators that have steadily climbed through the years. With a growing presence in Brazil and Germany, Roku hopes that it can find the same success in other countries that it has achieved in North America.
Improved financial profile
Over the past eight fiscal years, Roku turned a profit in just one of those 12-month periods. This is a familiar story with what are considered high-growth tech stocks. Investors are intrigued by their potential to produce sustainable positive net income far in the future, as opposed to in the present, as the focus should be entirely on gaining market share.
Supply chain issues and inflationary pressures led to a negative gross margin for Roku's hardware segment, but in the latest quarter, this turned to a positive 3.4%. The platform segment, which is where ad and subscription revenue lies, is very high margin. The hope is that as less of the company's overall sales come from low-margin hardware, profitability will follow.
The goal is to achieve positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) for the full year 2024. Optimizing expenses will help.
Management is optimistic about the company's long-term prospects because of the fact that 50% of TV viewing time in the U.S. comes from streaming, but only 22% of ad dollars are here. The gap should close in the decade ahead.
Re-rating the stock
As I noted earlier, Roku shares are down significantly off their peak, even though they've been on a nice run in 2023. As of this writing, the stock trades at a price-to-sales (P/S) multiple of 2.8, which is a huge discount to its trailing-five-year average. And although these aren't really apples-to-apples comparisons, Roku sells for a cheaper P/S valuation than streaming leader Netflix and adtech firm The Trade Desk.
The takeaway for me is that Roku is priced as if there is still a ton of pessimism surrounding the business. And this isn't surprising, given that the company isn't growing like it was before and throughout the coronavirus pandemic. Moreover, headwinds facing the digital ad markets are also proving to be a challenge.
To be clear, Roku has to successfully navigate the streaming landscape, particularly as it faces stiff competition from the likes of tech giants like Apple, Amazon, and Alphabet, which all have a hand in the connected-TV space. But if it can find ways to continue posting strong growth over the long term, the stock could reward shareholders as its valuation increases.
