Roku (ROKU -10.29%) has seen its fair share of ups and downs since the pandemic boosted demand for video streaming. Revenue surged through the roof, and the bottom line even turned positive in 2021.
But in the last few quarters, Roku has experienced a significant reduction in its growth with the general reopening and challenges to the broad economy. The stock is still down 85% from its 2021 peak.
Yet, there are good reasons to remain optimistic about the company, so much so that I've added it to my watch list.
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Roku's long-term prospects look bright despite near-term challenges
Roku was a significant beneficiary during pandemic lockdowns. With little in the way of entertainment, consumers turned to streaming, and many tried to save money by shifting from cable and satellite TV to platforms like Roku.
But those tailwinds have turned into headwinds as global economies have reopened. Meanwhile, the U.S. advertising industry has contracted as marketers tighten their purse strings amid an uncertain economic outlook. Roku's revenue growth fell from 55% in 2021 to just 13% last year. Results have further stagnated with the top line essentially flat year over year in the first quarter of 2023. The silver lining here is that revenue returned to growth of 11% in the second quarter, although that still lags its historical trajectory.
While its near-term performance has been mixed, its long-term prospects remain positive as the company looks ready to ride some powerful trends in the coming years. For instance, the global video streaming market reached $455 billion in 2022 and is expected to hit $1.9 trillion in 2030, implying a compound annual growth rate of 19%.
Connected-TV advertising globally totaled $22.9 billion in 2022, according to Statista, and it will reach $42.5 billion by 2028. As the best-selling smart-TV operating system in the U.S. in the first quarter with a 43% market share, Roku is well positioned to leverage these significant tailwinds.
Key engagement metrics are moving in the right direction too, even though revenue growth fizzled out in 2022. It added about 10 million active accounts last year, bringing its total to 70 million, and streaming hours were up 19% to 87.4 billion. These metrics have continued to improve in 2023, reaching 73.5 million active accounts and 25.1 billion hours in the second quarter.
If it can improve its engagement metrics further, that should help strengthen its monetization.
Roku's valuation has come down dramatically
When the pandemic hit in 2020, investors predicted that companies like Roku would permanently shift into a higher growth mode. Everyone rushed into the stock, sending its valuation soaring.
As a result, Roku once traded at a price-to-sales (P/S) ratio of more than 33. But investors were too bullish, which led to a massive correction. As of this writing, it has a P/S of just under 4, 90% below its peak.
I wouldn't say that's cheap, but if Roku can recover some of its previous momentum (revenue increased 40% to 50% annually between 2018 and 2021), its current valuation looks attractive.
So depending on whether investors think the current slowdown is temporary or permanent, the valuation will range from cheap to fair. In any case, owning Roku's stock at today's valuation is significantly safer than it was two years ago.
Roku is on my watch list
With cord-cutting and ad-supported streaming showing continued momentum, Roku's long-term prospects remain bright despite its current challenges. And with its valuation still crawling near multiyear lows, the stock stands out as a potential investment candidate.
But first, the company must demonstrate that it can sustain the growth of streaming hours in the next few quarters. Second, and more importantly, it must show that its revenue slowdown is temporary. While revenue was up in the second quarter, possibly marking the start of its recovery, management guided for just 7% year-over-year growth in the current period.
Until it delivers on both fronts to support a more bullish outlook, it will remain on my watch list.
