Shares of Roku (ROKU 1.33%) have trounced the Nasdaq Composite Index in 2023, up 106% as of Sept. 7. The market seems to be intrigued once again by growth tech businesses. But despite this renewed optimism, shares are still 82% off their all-time high, and they trade at a historically cheap price-to-sales ratio of 3.7.
Even though it has done so well this year, now might still be a good time to consider adding this streaming stock to your portfolio. But there's also a key risk to keep in mind.
Here are three compelling reasons that investors should buy Roku, as well as one important reason to sell.
Riding streaming's growth
As an agnostic three-sided platform that brings together viewers, content, and advertisers, Roku is in a prime position to benefit from the cord-cutting secular trend. There are currently 60 million households in the U.S. that still have a traditional cable-TV subscription, but this is down considerably from the peak of 100 million a decade ago.
According to data from Nielsen, hours spent streaming content exceeded time spent watching broadcast and cable TV by far in the month of July. A better user experience, with lower prices, greater choice, and more convenience, has catapulted the streaming industry in the past decade. And it should keep propelling the market, with even more time going to streaming entertainment.
Roku also benefits from the tens of billions of dollars that content producers like Netflix and Walt Disney spend each year. More of their TV shows and movies make the company more attractive to viewers. And a top market share in the U.S. among smart-TV operating systems is another advantage.
Recovering from macro headwinds
A softer digital ad market meant Roku's platform revenue only increased by 11% in the second quarter (ended June 30). Higher interest rates, elevated inflation, and fears of a recession have hurt ad spending. But this should be a temporary headwind. Once sentiment about the economy improves, the company's financials should see a lift.
On the hardware side, supply chain bottlenecks and inflationary pressures raised the cost for components for Roku's hardware products, like its smart TVs and dongles. But management decided not to pass higher costs on to consumers, which resulted in a negative gross margin on hardware sales in four of the last five quarters. Once these issues normalize, things could start trending in the right direction.
A path to profitability
Besides the positive net income of $242 million generated in 2021, an outlier year that was boosted by pandemic-related home confinement, Roku has typically been a money-losing company. Through the first six months of 2023, the business posted an operating loss of $338 million. This lack of profitability can be a major red flag for some investors.
But according to its management, that could change soon. By controlling operating expenses to better match revenue growth, it believes that Roku will be able to register positive adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) in 2024.
The red flag: fierce competition
The arguments in favor of buying Roku stock are certainly compelling. But investors can't ignore just how competitive the streaming industry is. The company has to go up against some of the most dominant and financially sound enterprises in the world today: Apple, Amazon, and Alphabet.
These three tech giants develop and sell hardware that rivals Roku's media sticks and smart TVs. They also have their own streaming services with Apple TV+, Prime Video, and YouTube.
Any internet business must always deal with the constant threat that these tech companies present. And Roku's situation is no different. Because of the streaming sector's growth prospects, there's intense competition for eyeballs and ad dollars. Roku has its work cut out for it.
