Media-streaming platform veteran Roku (ROKU -10.29%) turned some heads with a strong earnings report on Friday. The company beat management's guidance targets across the board, ran rough-shod over Wall Street's guidance-based estimates, and sent the stock skyrocketing. When the closing bell rang, Roku investors had pocketed a 31.4% gain in a single day.
Taking a deeper look at the business results and management commentary, I found three solid reasons to put more money into my existing Roku investment. But no earnings report is ever perfect, and one issue stuck out like a sore thumb. Can the upsides inspire you to pick up a couple of Roku shares? Is the single flaw a deal-breaker for you? I'll show you what I mean, so you can make the right decision for your portfolio.
Let's start with the reasons to buy Roku right now.
1. Ad sales are bouncing back, one sector at a time
Roku isn't too keen on breaking down its ad sales in detail, because the exact makeup of its business opportunities is an important trade secret. However, management spilled the beans on the market development in this week's report.
Two ad sectors were highlighted as particularly strong rebound performers.
The first was consumer packaged goods (CPG), including a sponsored McDonald's (MCD -0.91%) section of the Roku City screensaver. This marketing channel is a high-margin operation for Roku, and bubbling brand-building ad interest from household names like McDonald's could shift this revenue stream into overdrive.
Second, Roku reported solid gains in ad sales related to health and wellness products. This boost suggests that the freshly signed shopping partnership with Shopify (SHOP 1.11%) should be fruitful. The deal places shoppable ads on your Roku screen and you can place a Shopify-managed order through a couple of clicks with your TV remove. Early ad buyers in this service include Unilever's (UL 0.63%) Olly brand of nutrition supplements and the privately held rowing machine maker Ergatta.
So Roku City looks like a solid growth driver with an assist from McDonald's, and the Shopify service launched into a promising market opportunity. Other sectors may follow as the global economy recovers from the recent inflation crisis, but these are the frontrunners of Roku's positive advertising trend.
2: Roku is diversifying its business
I already mentioned the burgeoning Roku City platform and the brand-new ad-based shopping service managed by Shopify, but there's more.
According to Nielsen Media surveys, the Roku Channel is already a significant platform for new material, accounting for 3% of consumers' streaming TV time in the second quarter. The level of viewer engagement is comparable to established streaming services such as Warner Bros. Discovery 's MAX and Comcast's Peacock.
A Roku-branded line of smart TV sets may have sounded silly at first, since the service-independent platform specialist values the ability to strike deals and partnerships with any device maker. But the line of 11 Roku TV models, sold exclusively at Best Buy (BBY -0.25%), is winning awards and generating sales. These devices, always featuring the full range of Roku's features and services, will never be Roku's main business, but CEO Anthony Wood sees them as a friendly gateway to the company's primary products.
"TVs are now the most important way that we add active accounts," Wood said on the earnings call. "The Roku branded program is something that's new, it's going well, and it's got a few different purposes. [...] The Roku-branded program is incremental to [the software licensing program], if we see it driving innovation."
Roku is elaborating on its simple media-streaming platform operation in many ways, and also expanding its market reach in places like South America and Western Europe. Even if the advertising recovery takes a while, these ideas should help Roku deliver organic business growth.
Image source: Getty Images.
3: The company is growing in all the right places
Roku added 1.9 million net new active accounts in the second quarter and 10.4 million new names compared to the year-ago period. That's a 16% increase, despite a tough economy and widespread slowdowns across the entertainment sector.
At the same time, Roku's streaming hours rose at an even faster 21% pace year over year, stopping at 25.1 billion hours in the second quarter. The company is not only adding more accounts, but also earning more screen time with the average viewer.
That's how you build a robust user base that should stay loyal in the long run. Roku can focus on profits and cash flows later. So far, the big idea is to keep adding users and deeper engagement. Since the company started as a streaming hardware division of Netflix (NFLX -0.63%), it makes sense to see Anthony Wood copying that overarching strategy verbatim from the old mothership.
Netflix has finally shifted into a profit-seeking gear, 12 years after making a business out of the streaming service. Roku's global growth story is still in its infancy, and I don't mind waiting several years for sustainable profits. With this delayed profit plan, the income at the end of the streaming rainbow grows so much larger.
Image source: Getty Images.
1 reason to sell Roku: The most important target market is also the worst performer
While there are several reasons to applaud Roku's performance, there's a glaring concern we can't ignore: the media and entertainment (M&E) sector. Traditionally, M&E is Roku's largest and most significant ad-buying sector -- logically so, as many advertisers offer services directly through the Roku platform. If you see an ad for something you like, it's easy to sign up for another service right there on your TV.
However, the M&E sector isn't holding up its end of the bargain. Rather than leading the charge, it's lagging behind, with a recovery timeline that seems more like a marathon than a sprint. The reason? Now that the economy is getting back on track, the ongoing strikes among Hollywood's unions for writers and actors may undermine the entertainment industry's near-term prospects.
This troubled period is not when we should expect a quick recovery to full health, which is a bitter pill to swallow for investors looking at Roku's otherwise robust performance. No investment is ever completely free of weak spots, and in Roku's case, the slow ad orders from the M&E sector could be a cause for significant concern.
To wrap it up, despite Friday's exciting price jump, Roku's shares have merely returned to their position a year ago, with a modest 2% increase in 52 weeks. So if you thought you'd missed your chance to jump aboard the Roku bandwagon, think again. I believed Roku was undervalued last summer, and even after this impressive leap, I stand by that sentiment. The stock was even cheaper before the earnings report, but the higher price also gained support from a rock-solid business update. I'm just as interested in doubling down on my Roku investment now as I was last week.
