Roku (ROKU 1.50%) stock is a favorite on Wall Street these days. Sure, the streaming video platform's shares are well below the highs that investors saw during the pandemic rally. But they've doubled so far in 2023 compared to a 15% increase in the S&P 500 index.
Stock price gains at those levels don't happen without some good reasons for optimism on the business. Yet the Roku rally might also have gotten ahead of itself, potentially creating an opportunity to book some profits. Let's look at a big reason to buy Roku stock today, along with one reason to sell it.
A reason to buy: The future is bright
There were several indications in Roku's latest results that suggest the platform has excellent positioning in an industry that's set to grow for decades. Sure, sales growth was modest at just 11% in the second quarter. But Roku gained 1.9 million new viewers compared to the previous quarter and is serving far more digital entertainment to its base.
A record 74 million accounts regularly stream using its platform today. And streaming hours were up over 20% to 25 billion year over year. For context, Netflix counts 240 million subscribers today. Roku also passed a key milestone, crossing 1% of total TV viewing, according to Nielsen, compared to Netflix's 9%. In other words, there's a long runway for growth ahead as traditional TV loses subscribers in the next decade and Roku captures more than its fair share of those cord-cutters.
A reason to sell: The finances
Roku is highly dependent on digital advertising trends, which haven't been strong over the past year or so. The company has made positive strides at lessening this reliance, including by improving its ad delivery platform to include innovative options like direct purchasing. But revenue from its core platform service hasn't been nearly enough to establish a record for positive earnings.
ROKU Operating Margin (TTM) data by YCharts
On the contrary, Roku's operating profit margin is in deeply negative territory and has been trending lower recently. In contrast, Netflix, with its subscription model, kept steady profitability of between 18% of sales and 20% of sales, even through the growth swings of the pandemic and its aftermath.
This difference looks even worse when you consider how much more expensive Roku's stock has become. It was valued at about 1.5 times sales at the start of 2023 but investors now have to pay over 3 times sales for the business. Netflix, which has much larger scale, cash flow, and annual earnings, is valued at about 6 times sales.
The winning approach
An investment in Roku offers the potential for faster growth over the next few years, especially as the digital advertising industry enters its next cyclical upturn. Those ads will be more efficient and will be served to a much larger base of active users over time, likely boosting their value (and prices). And there's always the prospect of more game-changing innovations like Roku's recent partnership with Shopify.
As a result, investors have good reasons to look past Roku's weak finances and focus instead on its growth and long-term earnings potential. Earnings trends will likely follow market share and engagement gains. And Roku is achieving these successes while preparing for the inevitable rebound in the digital advertising world. The bulls seem to have the right idea on this stock.
