Roku (ROKU -10.29%) stock has been on a tear of late. As economic conditions have been looking better, the streaming company has benefited from more excitement and bullishness around growth stocks. Shares of Roku aren't quite at their 52-week high, but they rallied 60% in just the past three months. Can this rally continue, or could Roku stock be running out of steam?
Why Roku could be due for a strong Q4 result
Roku will release its latest earnings numbers in February, and there are reasons to be optimistic the report will be a good one for the company. A big concern for Roku in previous quarters has been a lack of profitability, particularly its poor gross profit margin.
In the third quarter, the company's gross margin was just over 40%. And despite revenue rising 20% year over year to $912 million, gross profit only improved 3%. Lackluster gross margins aren't a new problem for the company.
Data by YCharts.
But what hurt the company's gross margin last quarter were restructuring charges totaling $62 million. If not for those nonrecurring expenses, the company says its gross profit would have improved 22% year over year.
Provided that Roku doesn't incur any surprise expenses for the fourth quarter, it may benefit from a stronger gross margin. And with better margins, the company's bottom line should also show improvement. Roku's operating loss was just under $350 million last quarter, more than double the $147 million loss it incurred in the prior-year period, but like gross profit, restructuring charges contributed substantially to the third quarter's operating losses.
While revenue growth on its own may not be enough to send the stock back to its earlier highs, improvements to profitability could convince investors the business is moving in the right direction.
Roku's valuation is fairly low
Although Roku stock has been doing well of late, in the context of its price-to-sales (P/S) multiple, its valuation still appears fairly modest.
Data by YCharts.
Over the past five years, the stock has averaged a P/S multiple of more than 11. But given the company's struggles with slowing growth and mounting losses, investors have clearly been taking a more cautious approach, no longer willing to pay such a premium for the business.
And Roku's operations remain risky as the company has begun producing its own TVs. While the new products may stimulate top-line growth, that won't necessarily translate into higher profits. Roku has typically incurred gross losses on its hardware sales, while the company's platform (i.e., ad revenue) picks up the slack.
Should you invest in Roku stock today?
Roku plays an important role in the streaming industry as consumers' preferred gathering place for multiple apps. But the management's decision to push further into hardware adds to the uncertainty behind the stock.
Until Roku can prove that it has a path to sustainable profitability, the streaming leader may not be able to command the same market premium as it did in the past. This is a stock I'd put on a watch list rather than buy because I'm not convinced it can keep up its recent momentum, especially if the upcoming earnings report proves underwhelming.
