Roku (ROKU -3.11%) stock has been on fire lately, up by more than 85% year to date. While Roku's near term doesn't look too exciting, investors are exploring the possibility for the company to revert to its high-growth mode in the mid to longer term.
But before rushing to buy the stock, investors need to know some fundamentals about the company. This article will look at two critical aspects of the company that most smart investors already know.
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A quick overview of Roku's economic engine
Roku is a company that enables consumers to stream online content on their TV. Connecting Roku's software-powered devices -- such as streaming player, streaming stick, etc. -- to their TV, consumers can enjoy a wide range of content (such as video and music) on their big screen.
And here's where Roku's business model comes into play. When customers use a Roku device, they don't have to pay any subscription fees to Roku -- they only have to pay for the device. However, Roku partners with different streaming services, like Netflix, Hulu, and Disney+, to name a few. These streaming services create apps that viewers can download onto their Roku devices. And when users subscribe to any of these services and start streaming their content, Roku gets a cut of the subscription revenue. It's like a commission that Roku earns for bringing these streaming services to consumers.
Roku also earns money through advertising. Via its channel (Roku Channel), the company offers viewers ad-supported free movies and shows. As these contents are free, Roku will display ads to its 72 million viewers when they watch content on the Roku Channel. In return, Roku will earn advertising revenue from advertisers.
In 2022, Roku generated 87% of its revenue from its platform -- mainly from advertising and content distribution -- and the remaining from the sales of devices. The latter didn't generate any gross profit for Roku, as it tries to sell its devices at low prices to scale quickly. The company also remained unprofitable amid its expansion efforts.
What can investors expect from Roku in the coming years?
When the pandemic hit in 2020, Roku benefited enormously thanks to the growth in streaming hours and active users. Revenue grew by 58 % and 55%, respectively, in 2020 and 2021.
But as the global economy reopened and consumers spent more time outdoors, Roku got hit right in the face. It didn't help that the macro environment became challenging for the advertising industry (the U.S. advertising market fell 7.4% in the first quarter of 2023). Unsurprisingly, Roku's revenue growth rate fell to 13% in 2022 and 1% in the first quarter of 2023. This headwind could continue for a while until the economy improves.
Longer-term, however, the company still has a bright prospect. The streaming market has been booming in recent years, and this tailwind will continue. As more people cut the cord and shift from traditional cable or satellite TV to streaming services, Roku is well positioned to benefit from this trend. In fact, Roku's streaming hours grew 20% year over year in the first quarter of 2023, compared to traditional TV viewing hours, down by 10%. As Roku continues to expand its active users and user engagement, it stands in an excellent position to improve its monetization on advertising, content distribution, and others.
Besides, the move toward streaming is a global trend. So while Roku has a significant presence in the United States, there are still massive opportunities for international expansion. To this end, Roku can leverage its brand recognition and know-how to enter (and expand) new markets. The tech company must tailor its expansion strategy to local nuances (such as culture and language) to compete effectively against existing competitors. Still, while not being straightforward, its overseas expansion efforts will likely be worthwhile in the long run.
In short, Roku could see more short-term pain -- if the macro environment deteriorates further -- but its long-term potential remains intact.
