Wall Street has already tuned back into Roku (ROKU -0.98%) stock. The streaming service specialist's shares are up over 80% so far this year, trouncing the 16% increase in the S&P 500 and leaving industry leader Netflix in the dust as well.
But are investors getting ahead of themselves on this still unprofitable business?
Roku has been showing better sales trends lately as the digital advertising industry recovers from its post-pandemic slump. Yet the company isn't on a strong financial footing right now. Let's take a closer look at whether investors can still count on strong returns buying this stock following its year-to-date rally.
Why the rally?
There are some good reasons for Roku's stock to be rallying this year. For starters, the company returned to growth in its second quarter as revenue rose 11%. That follows the two previous quarters when revenue was flat year over year. And for the current period, management is guiding for the top line to rise 7%.
The platform has always shown excellent engagement trends. Last quarter, streaming hours were up more than 20% year over year to 25.1 billion, and the company added 1.9 million new user accounts to reach 73.5 million.
Combined with a new push for efficiency, this growth could power some big steps toward profitability. In early September, the company announced layoffs for roughly 10% of its workforce as part of a bigger restructuring plan aimed at reducing expenses.
It's too early to say exactly how this move will affect future earnings. But investors are looking for net losses to moderate from here, reversing recent trends. Roku posted $302 million of red ink in the first half of 2023, compared with a $139 million loss a year earlier.
A few question marks
Two big risks should temper Wall Street's enthusiasm. Unlike Netflix, Roku is heavily dependent on the health of the TV advertising world rather than on the steadily rising subscription fees that fund the streaming leader's strong cash flow. That factor exposes Roku to another slowdown if major advertisers decide to pull back on spending again.
Roku is projecting a return to modest profitability in 2024, meanwhile, but only on an adjusted EBITDA basis. It's unclear when, if ever, Roku can achieve anything approaching the 20% operating profit margin that Netflix routinely delivers. Investors should keep these financial and operating risks in mind when considering whether the stock is a buy at today's prices.
Timing is everything
On balance, the bullish thesis makes more sense for this stock. Roku is steadily growing engagement metrics even as pay-TV usage shrinks. It's boosting the value of its service for advertisers as well, thanks to the kind of tech innovation that's only possible when you own your platform.
Combined with its growing scale and a direct relationship with a growing pool of nearly 80 million customers, these assets give management lots of flexibility and many avenues to target for growth. And a declining cost burden should serve to accelerate Roku's move toward sustainable profitability.
Cautious investors might want to watch the stock for another quarter or two to see confirmation that the streaming video giant is still on the right path. But the best returns will come to shareholders who don't mind taking on a bit more risk. Roku stock still has room to produce market-beating returns as its earnings picture improves in 2024 and beyond.
