Wall Street is excited again about the potential for Roku's (ROKU -1.49%) business to grow over the next few years. The streaming video giant's stock has trounced the market so far in 2023, even beating Netflix's (NFLX 0.79%) rally through late June. Investors are looking forward to stabilizing sales trends ahead, and some potentially strong earnings as profit margins rebound.
There are some factors about Roku's business that make it riskier than Netflix, though, despite its bright long-term growth outlook. With that in mind, let's take a closer look at Roku as a potential long-term investment.
1. Ads over subscriptions
Netflix's move into the advertising market has helped lift investors' spirits, but in Roku's case the company may be too reliant on this volatile industry. The core U.S. ad market shrank at a 7% rate in Q1, for example, which helped push Roku's growth rate down to just 1%. That nearly flat result came despite strong engagement trends and record watch time.
Netflix can more easily cash in on its rising engagement because it relies almost entirely on subscription fees. Sales rose 4% last quarter, or roughly on par with the 5% boost in the subscriber base. The bullish Roku investing thesis relies on the company diversifying over time so that ads aren't as important to the business. But that shift could take several years.
2. Great engagement
The good news is that people are loving Roku's platform and its content. Active accounts improved to 71.6 million last quarter, up 1.6 million from the prior quarter. Streaming hours jumped 20% year over year to 25 billion. "Roku continues to delight viewers and partner with some of the biggest brands and global entertainment companies," executives said in a late-April letter to shareholders.
This high engagement opens many avenues for growth, whether it's through new innovative advertising partnerships, sales of smart TVs, or marketing subscriptions for smart home devices. Its push deeper into original content is highly likely to deliver good returns, too, just as it has for Netflix over the past decade. Roku has many ways it can capitalize on its dominant position in smart TVs and ad-supported streaming.
3. Keep watching
Smart investors know that the stock looks a bit expensive, both compared to its recent valuation and to its more profitable peers. You have to pay nearly 3 times annual sales for Roku today, compared to below 2 at the start of the year.
Sure, Netflix is more expensive with its price-to-sales ratio of nearly 6. But the subscription streaming giant is highly profitable with an operating margin routinely landing above 20% of sales. Roku's comparable figure is closer to a 20% loss.
That's why investors should wait before jumping into the Roku rebound story. The business has a bright growth outlook, especially as the advertising market stabilizes and then returns to growth over the next several quarters. Yet the company hasn't demonstrated a clear path toward sustainably strong profit margins.
Watch the stock over the next few quarters for more concrete progress along those lines.