The market rallied as 2023 closed out, but it wasn't quite enough to get us out of this bear market, at least officially. Stocks initially jumped on the promise of future interest rate action, but so far many companies are still feeling the impact of current monetary policy. So valuations of many stocks remain reasonable right now.
One prime example is streaming stock Roku (ROKU -10.29%), which trades at an 80% discount to its previous highs. It's fair to say that the previous high was unreasonable, but where it stands now, Roku stock trades at less than 4 times trailing 12-month sales. Let's see why it's a screaming buy at this price.
The leader in ad-supported streaming
Roku is known for its streaming devices. It operates the top streaming operating system in the U.S. and Mexico, even up against the likes of Amazon.
However, its main business is selling ad space on its channels. It had an ad-supported platform way before networks like Netflix and Walt Disney joined the fray, and it has built strong relationships with its clients. It has demonstrated that ads on its channels produce results, and it has created innovative partnerships for single-show sponsorships and other kinds of advertising outside of the 30-second clip.
Roku resisted the urge to raise prices on its devices when it became more expensive to produce them, taking a hit on both revenue and earnings. That's because the devices are the gateway to bringing customers into its ecosystem and getting them watching on the Roku platform.
The most important metrics for Roku are streaming accounts and viewing hours, because the more it has, the more ad space it can sell and the more it can recruit advertisers by demonstrating that it has more eyeballs. These metrics have been mostly outstanding. In the 2023 third quarter, active accounts increased 16% year over year, and streaming hours increased 22%. Both of these metrics were also up sequentially.
After a few years of declines, the device business is now on the mend. There was some short-term pressure in the ad business as well, since advertisers have been curtailing their budgets due to inflation. But that looks like it's beginning to ease too.
Scaling leads to profits
Roku's growth soared during the early days of the pandemic when people were staying indoors, and Roku briefly posted a surprise profit. But that disrupted what might have been a more gradual and organic process, and it's been deeply unprofitable since then. However, having posted profits at scale can breed confidence that it can do it again.
There have been a multitude of economic challenges over the past few years, and it looks like Roku has remained resilient. Both of its segments, devices and platform (advertising), reported double-digit sales increases in Q3 2023, with a 20% year-over-year increase for the total company. Gross profit increased 3%, but gross margin narrowed from 46.9% to 40.4%. Roku posted a $138 million operating loss.
However, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) -- which strips out one-time charges, restructuring expenses, and other expenses that management feels are outside of the core business activities -- increased from a $34.4 million loss last year to positive $43.4 million this year.
It will still be an uphill climb to become net profitable. But management is taking a measured approach, and looking to get there gradually, like its original plan. It's increasing its presence internationally, fostering new relationships with partners, and improving its user interface. Management is still cautious about the operating environment, but it's committed to generating positive EBITDA for the full year of 2024.
Roku stock gained 113% in 2023, but it's still at the beginning of its journey, and at this price, it looks like a screaming buy.
