On Feb. 12, Roku (ROKU +2.62%) stock was trading at nearly $100 per share. As of this writing, just 11 days later, it trades at about $63 per share.
Perhaps the biggest issue contributing to Roku's price drop right now is Walmart's (WMT 0.23%) planned $2.3 billion acquisition of Vizio (VZIO +0.00%). Roku stock plunged on both the rumor of the deal and the subsequent official announcement on Feb. 20.
Roku lost ground in February for other reasons as well. The company's main source of revenue is its platform revenue, which largely consists of digital advertising. It reported fourth-quarter and full-year financial results on Feb. 15, showing an encouraging 10% growth in platform revenue in 2023. However, its gross margin for platform revenue dropped from 56% in 2022 to 52% in 2023.
NASDAQ: ROKU
Key Data Points
It's understandable why investors are worried. Walmart accounts for a significant percentage of Roku's device sales, and it's an advertising partner as well. Moreover, advertising revenue is a high-margin opportunity. But there are legitimate questions about the potential for Roku now considering its declining gross margin for platform revenue.
In the wake of the recent sell-off, Roku stock trades at just 2.6 times its trailing sales. That's almost an all-time low valuation for the company. Should investors buy it now while its valuation is cheap, hoping for better financial results in the future?
ROKU PS Ratio data by YCharts.
Why this could be the time to buy
Roku ended 2023 with 80 million active accounts, and those users streamed an astounding 106 billion hours of video content during the year. The trend has been underway for years, but increasingly more people are watching connected TV instead of traditional TV. This has enormous implications for the advertising industry.
According to research company GroupM, ad revenue for connected TV platforms was up 11% in 2023 and is expected to grow by nearly 14% in 2024. It's one area of the ad industry that refuses to slow. Roku has forecast that its revenue will go up by nearly 15% year over year in 2024's first quarter -- in line with the 14% growth for the connected TV industry predicted by GroupM. That's a good sign.
The secular trends are still in Roku's favor, and the company has a larger audience to monetize than ever before. These points alone are enough to warrant giving Roku stock a closer look at its opportunistically low valuation.
Moreover, a good portion of Roku's recent drop was driven by concerns about how Walmart's acquisition of Vizio would impact the streaming specialist's business, but those concerns may be exaggerated. Indeed, Needham analyst Laura Martin believes this deal could actually benefit Roku. According to Business Insider, in a report she released Wednesday, Martin points out that it's possible that Walmart's retail competitors won't be keen on selling Vizio TVs in their stores anymore. The result of that could be chains giving more prominent placement to Roku's TVs and devices on their shelves.
Even if Martin is wrong, it will take time for Walmart's acquisition of Vizio to materially change the competitive landscape. Roku investors should have plenty of time to assess the competitive risk while it's materializing.
For now, Walmart CEO Doug McMillon said in an interview on CNBC that the company is not going all-in on Vizio. Walmart still values all of its partners, including Roku, he said.
Therefore, Roku's business might not skip a beat. Assuming its business holds strong and advertising demand grows at rates similar to what the analysts predict, this stock could be a market-beating investment today.
A closing caveat
This month's swift sell-off for Roku stock did highlight one deeper issue that investors may be grappling with: The company might not have a durable competitive advantage.
Don't misunderstand: Roku is outcompeting its bigger tech rivals that have connected TV operating systems of their own. That's an important point that can't be overlooked. However, it's the durability of Roku's market position that's in question. It is fairly easy for users to switch to a competing provider of TVs or a different connected TV platform. I believe the market understands this, which helps explain why it reacted so sharply to the Vizio acquisition.
With some stocks, investors can buy shares and largely forget about them -- some businesses have competitive advantages that are very durable, and the investment thesis for such companies won't quickly change. By contrast, other stocks can still make good investments, but investors might need to more actively keep a finger on the pulse of the company.
I'd put Roku stock in the latter category. There's still reason to believe it can be a good investment. But investors will want to keep close tabs on its user metrics and its gross margins in coming quarters. Deteriorations in these metrics could point to rising competitive pressures that investors might want to avoid.
