Technology stocks have been on an absolute tear recently. But these returns have been concentrated in a few mega-cap names and beneficiaries of the artificial intelligence (AI) boom. It might not seem like it when looking at the broad market's return charts, but many smaller technology stocks are doing terribly.
One stock that has gone through major struggles is Roku (ROKU -10.29%). The streaming-TV platform is off 87% from all-time highs, with the stock falling 30% after its latest earnings report earlier this month. Let's try to figure out what went wrong, and whether shares are finally a buy at these bottomed-out prices.
Growing usage, but no profits
Roku is known for its streaming TVs and media-viewing software platform, operating as the portal for many people to access streaming channels and internet-connected TV services such as Netflix or Disney's Disney+. This year, it continued to grow its presence across North America and in other global regions. Active Roku accounts hit 80 million in the fourth quarter of 2023, up 14% year over year.
Usage among these active accounts continues to grow, with total streaming hours passing 100 billion in 2023 and growing 21% year over year in the fourth quarter. Importantly, Roku's proprietary Roku Channel streaming service grew usage by 63% year over year and is now one of the largest services in the United States. The Roku Channel could prove a valuable asset since it gives Roku vertical integration -- controlling several stages of the consumer's entertainment experience -- and perhaps some negotiating leverage when talking with advertisers.
To make money, Roku has built (and continues to build) advertising and promotional services for the streaming platform. The problem is, monetization is growing slower than usage. Platform revenue -- which is essentially advertising revenue -- grew 13% year over year in the fourth quarter, with revenue per user down 4% year over year in 2023. This led to another year without profits, posting an operating loss of $793 million in 2023 compared to $531 million in 2022.
The numbers are moving in the wrong direction, and investors are not happy. This is why the stock sold off yet again to start the year.
How big does the streaming platform need to get?
Roku has shown it can consistently increase its active users. It is now a top streaming TV operator in Canada and Mexico, with plans to spread across other Latin American markets.
With its 80 million accounts and over 500 million people living in Canada, the United States, and Mexico, there is plenty of room to grow in its core markets. And in the United Kingdom, Roku now has many TV models for sale.
Advertising will certainly follow usage, but the concern should be: Do these advertisers need -- let alone want -- to use Roku? Today, despite Roku's massive scale, many ad buyers appear to prefer platforms like YouTube instead.
YouTube had $9.2 billion in advertising revenue in the fourth quarter, which Roku didn't see any of. Its entire 2023 revenue (some of which isn't advertising) was under $3.5 billion.
Right now, people are spending a lot of time using Roku's platform with the company earning little in return, which is a bad situation.
Only one thing matters for shareholders: profits
A company can grow its revenue all it wants. But for shareholders, what truly matters over the long term are earnings. Roku lost over $700 million last year and will likely lose money again in 2024.
Even if we assume it could generate a profit if it wanted to pull back on growth initiatives, the stock does not look cheap. On a theoretical 10% profit margin, Roku would be generating $350 million in annual earnings on $3.5 billion in revenue. If that revenue grows to $5 billion, Roku could perhaps be generating $500 million in earnings within a few years.
The company now has a market cap of $9 billion. If it had $350 million in earnings, it would have a price-to-earnings ratio (P/E) of 26, and on $500 million in earnings, it would have a P/E of 18. Neither of these looks very cheap, especially when you remember these are theoretical earnings that Roku is not generating today.
Either you expect Roku to grow its revenue substantially over the next few years, or you believe it will see a huge inflection in its profit margins. Otherwise, it is best to avoid the stock despite its huge decline in price.
