Over the last several years, cutting the cord with cable providers has become trendy as people flock to streaming services. While Netflix dominates the streaming market, there are a number of other players looking to compete. Ark Invest CEO Cathie Wood, who is known for her lofty forecasts in emerging tech, is betting big on a budding streaming platform called Roku (ROKU -10.29%).
According to Wood's analysis, Roku stock could reach $1,500 by 2026 -- implying 1,340% upside from current trading levels. Let's assess Wood's forecast and compare the assumptions to Roku's actual performance.
What's behind Wood's forecast?
Wood is known for sharing her logic behind bullish calls. In the case of Roku, Ark Invest published a financial model to its website which breaks down the firm's assumptions behind the $1,500 price target on Roku. The model includes three cases: Downside, base, and upside. The $1,500 price target comes from Wood's upside case.
In the upside case, Ark Invest projects that Roku will reach $32 billion in revenue by 2026. The core assumptions behind this revenue target stem from the growth in connected TVs (CTVs). CTVs are commonly referred to as smart TVs -- those that can connect to the internet and stream content via apps like YouTube, Netflix, or Roku.
Wood's model suggests that by 2026, over 1.3 billion CTVs will be in use. Of that cohort, Roku will reach 186 million accounts, with each streaming five hours of content per day. By accumulating such a critical mass, Wood believes that Roku will command premium spend from video advertisers.
While Wood's theory is easy to follow, there are some assumptions that need a reality check.
Image source: Getty Images.
How's the company performing?
According to Roku's third-quarter earnings, ended Sept. 30, the company has 76 million active accounts. Right off the bat, Wood's forecast of reaching 186 million accounts within the next three years seems lofty. What's more is that attaining this figure is largely out of Roku's control. Roku has no real control over the pace at which smart TV adoption moves. Furthermore, not every CTV is necessarily using Roku's services.
But where Wood might be accurate is streaming hours. Roku's Q3 data shows that the company generated 3.9 streaming hours per day per active account during the September period. Given this data point, Wood's assumption of Roku reaching five hours of streamed content per day might be feasible.
Where Wood's model really seems to shift from reality is the assumption behind total revenue. Should Roku achieve its fourth-quarter sales guidance of $955 million, the company will generate $3.5 billion in revenue for 2023. In order for Roku to reach Wood's 2026 projection, revenue would need to 10x in the next three years. Not only is this highly unlikely, but where the revenue stems from and its contribution to operating profit are even more suspect.
Wood suggests that video advertising will contribute the most to revenue over the next few years and help Roku attain 67% gross margin. Roku's platform gross margin, which is where ads reside, has hovered around 50% throughout 2023. Moreover, it's important to point out that the biggest streamer out there, Netflix, has only recently turned to advertising as a revenue source -- and as of now, it's not exactly a rocket ship. The point here is that there is a lag between accumulating users, enticing advertisers to your platform, and actually monetizing a meaningful portion of your accounts.
Should you buy Roku stock?
The takeaway from this analysis is that Roku is likely to underperform Wood's targets. For this reason, Roku is probably not going to be the multi-bagger that Ark Invest suggests within the next three years. But that does not mean Roku is a poor company or a bad stock.
Roku stock is trading nearly 80% below its all-time highs. Like many stocks, Roku's pricing action got ahead of itself a couple of years ago and the stock became overbought. However, since then, the company has shown major signs of improvement on the expense side of the house, all while reaccelerating revenue growth during a challenging macroeconomic period.
CTVs are becoming more common, and the company should continue to benefit from this trend. As more smart TVs are in use, Roku should be able to capture additional ad spend, per Wood's outlook. However, the pace at which this growth occurs, and whether it will be at the margin rate she assumes, are my biggest question marks.
Current holders of the stock should employ a long-term mindset. Although Roku's revenue or stock price are likely not going to 10x in three years, owning the stock is almost like having a call option on the long-term story for streaming. Exercising patience could prove to be a wise decision for this once high-flying growth stock.
