When it comes to smart TV operating systems in the U.S., Roku (ROKU +3.12%) is undoubtedly a leader with a 43% market share -- higher than that of the next three operating systems combined. After a difficult 2022, this video streaming specialist's stock seems to be finally on the road to recovery, with shares gaining by 90% so far this year.
However, Cathie Wood's Ark Invest, is projecting a much higher growth potential for this stock. According to Ark's valuation model, published in July 2022, Roku's shares can be worth $605 by 2026 (base case). This implies an upside potential of around 680% from the current price.
While the price target may seem a tad bit unrealistic, investors should still consider this stock for its long-term growth potential. Here's why.
NASDAQ: ROKU
Key Data Points
Roku demonstrates strength in digital advertising
Streaming video pioneer Roku is emerging as a major beneficiary of the rapid expansion in the U.S. Connected TV (CTV) ad spending, which is estimated to grow from $24 billion in 2023 to $29.5 billion in 2024. The company has been leveraging the power of contextual artificial intelligence (AI) to effectively target audiences by running appropriate advertisements that match the content shown on the Roku Channel. The company also uses AI to make personalized content recommendations to viewers based on their previous surfing patterns and preferences, as well as to provide voice search and control capabilities on the platform.
Being the leading smart TV operating system and streaming content aggregator, Roku plays a major role in content discovery for viewers across multiple streaming content services. The company has also invested in several features, such as Roku Search and the free ad-supported Roku Channel, to improve customer engagement.
Thanks to the strength of its data-driven smart TV operating system, Roku managed to expand its active account base by 17% year over year to 71.6 million, while streaming hours grew by 20% year over year to 25 billion hours in the first quarter. Roku's average streaming hours per active account per day was a record high of 3.9 hours in the first quarter (ended March 31, 2023). The company is also expecting gradual improvement in its financial metrics. While not yet profitable, the company expects to become earnings before interest, taxes, depreciation, and amortization (EBITDA) positive in fiscal 2024.
Partnership with Shopify
To reduce its reliance on the macro-sensitive digital advertising market, Roku has partnered with Shopify (SHOP +2.29%) to integrate commerce with TV streaming. The deal will reduce the advertising funnel by enabling viewers to purchase Shopify products by clicking on Roku Action Ads and paying with Roku Pay directly through the television.
With Shopify accounting for roughly 10% of e-commerce in the U.S., this partnership is expected to dramatically improve the monetization of Roku's 71.6 million active account base. This is a win-win for both companies. While Shopify will get access to a captive audience (potentially more business from impulse purchases) and customer data about purchasing trends, Roku will enjoy better pricing power due to an improved purchase experience and precise channel measurements. This, in turn, is expected to boost the monetization of Roku's active accounts in the long run.
Ark's valuation model
Ark has included three possibilities in Roku's valuation. The base case price is predicted to be $605 by 2026, implying an upside potential of roughly 680%. The bullish case price is $1,493 (upside potential of 1,800%), while the bearish case price is $100 (upside potential of roughly 30%) by 2026.
Base case scenario assumptions: Ark is assuming Roku will have an active account base of 157 million daily hours streamed on Roku, 4.5 hours per active account, and a net platform monetization rate per hour of $0.05 by 2026. Subsequently, Roku's revenues and adjusted EBITDA margin are expected to reach $14 billion and 29%, respectively, by 2026. Ark expects Roku's market capitalization to be $93 billion by 2026, implying a price-to-sales ratio of 6.6 times.
The base case estimates seem difficult to achieve, considering that Roku's year-over-year revenue growth rate was just around 13% in fiscal 2022.
Is Roku a buy?
While Ark's price targets may be impractical, there is still a lot that investors can like about this stock. Viewers are increasingly shifting from linear television to CTV, which in turn has led to a boom in streaming services, including low-cost or free ad-supported ones.
According to consumer research from Leichtman Research Group, 88% of U.S. TV households had at least one internet-connected television (CTV) device in 2022, up from 82% in 2021. Further, 49% of U.S. TV households watch video on CTV daily, up from 39% in 2021. Understandably, CTV is also attracting a greater portion of advertising dollars. With Roku earning the bulk of its revenues from its platform business (from the sale of subscriptions for streaming services and advertisements), this secular tailwind will continue to drive the company's growth in the coming months.
Roku is currently trading at around 3.4 times trailing-twelve-month sales, close to its historically low valuation levels. Considering its many growth catalysts (secular and company-specific), investors should consider picking up a small position in this stock now.
