After a dismal 2022, it seems investors are once again warming to Roku (ROKU -10.29%). After plunging as much as 90%, Roku stock has come roaring back, soaring 92% so far this year.
While the company was battered by supply chain challenges, dismal macroeconomic conditions, and unrealistic pandemic-era comps, that didn't stop Roku from preparing for the future. It continued to grow its market share, hone its ad-targeting prowess, and wait for the inevitable economic recovery to come.
There are numerous reasons to believe this could be the beginning of a major multiyear run for Roku. Let's take a look at three.
Image source: Getty Images.
1. Cord-cutting is accelerating
Its no secret that people have been cutting the cord, but the extend to which the trend is accelerating is eye-opening.
Over the past year, the top pay-TV providers shed more than 5.36 million subscribers, compared to a loss of 3.57 million during the prior-year period, according to data compiled by Leichtman Research Group.
While the implications are dire for the cable industry, the trend is Roku's friend, as these viewers need to go somewhere for their in-home entertainment fix. Roku's dongles, set-top boxes, and connected TVs (CTV) are the go-to for these viewers, as evidenced by the company's growth. In the third quarter, Roku revealed that its active accounts had grown to a record 75.8 million, up 16% year over year, and adding 2.3 million sequentially. For perspective, the cable industry had less than 72 million, which means more people use Roku than all the major cable and satellite companies combined.
This extensive reach gives Roku growing leverage with the marketers that advertise on its platform, which provides the bulk of the company's revenue.
2. Roku devices are (mostly) sold at a loss
While Roku made its fortune on the back of its namesake streaming devices, its business model has changed. In order to grow its ecosystem, the company decided to sell its devices at or near cost, while leaning into its advertising business. That decision now seems prophetic.
In Q3, Roku's platform revenue, which is primarily from advertising, made up more than 86% of its total revenue. Furthermore, Roku active-account growth consistently trudges higher, adding more viewers, which provides more leverage with advertisers, further fueling the flywheel.
This, in turn, is helping improve the company's bottom line as the gross margin of the platform segment stands at roughly 48%. It makes perfect sense that Roku would sacrifice the razor-thin margins it makes on devices in order to entice more viewers to join the fold.
3. CTV -- Roku's secret weapon
One of the most underestimated strategies in the company's arsenal is the Roku operating system (OS). Once it decided to focus on building scale, Roku created its CTV OS from scratch rather than repurposing a mobile OS -- the strategy used by many of its competitors.
By taking ownership, Roku can license the OS to a growing number of television manufacturers to integrate into their CTVs rather than reinventing the wheel. This gives Roku access to many more living rooms, further expanding its user base.
The company took that strategy a step further earlier this year when it introduced Roku-branded televisions, which are designed, made, and sold by Roku. And these aren't second-rate products but rather the toast of the industry. But don't take my word for it. Here's a snippet from Roku's shareholder letter:
Popular Science named the Roku Plus Series the "Best Overall" TV. Forbes called the Roku Plus Series TV "one of the best value TVs on the market," stating that "Roku has done an amazing job of building a solid panel that will tick all the boxes for most homes." And ZDNet said, "Roku's first-ever TV is shockingly capable for the price you pay."
Furthermore, the company noted that "Roku [television] sales grew significantly faster than the industry ... and the Roku OS was again the No. 1 selling TV OS in the U.S."
The fine print
Each of these points continues to work in Roku's favor, setting the stage for its future success.
To say that Roku's Q3 financial report was well received would be an understatement. Active accounts of 75.8 million grew 16% year over year, and streaming hours of 26.7 billion climbed 22%. Roku's platform revenue -- including advertising, a subscription revenue split, and licensing revenue from its CTV OS -- grew 18%, while its device revenue increased 33%. Perhaps most importantly, the company delivered positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) for the first time since early 2022 and is on the verge of generally accepted accounting principles (GAAP) profitability. Investors cheered the results, driving Roku stock up nearly 31% on Thursday following its financial report.
Finally, at less than 3 times next year's sales, Roku remains a compelling bargain. But don't expect it to stay that way for long.
