I called Roku (ROKU -10.29%) a "fantastic buy" a couple of weeks ago, as the media-streaming technologist prepared its fourth-quarter earnings report, which hit the news wires a few days later. Roku's results were almost exactly in line with the average analyst's expectation, showing 13.5% year-over-year revenue growth while erasing two-thirds of its bottom-line losses.
Roku's stock plunged on the news. It closed 24% lower the next day, and the bearish action has added up to 33% since the report.
Is Roku suitable as an investment today? Was that report a harbinger of terrible business trends to come, or was it an invitation to pick up Roku stock on the cheap?
(Spoiler alert: I doubled down on my Roku investment last week. Here's why.)
Looking at Roku from a bearish angle
Fellow Fool David Jagielski recently explained why Roku's big price drop made sense to him, boiling it down to four main issues:
- The company faces many powerful rivals, led by the Amazon Fire line of smart-TV solutions. Retail titan Walmart (WMT -0.08%) is joining the fray by picking up smart-TV specialist Vizio (VZIO -0.09%) in a $2 billion buyout. The lineup of deep-pocketed industry giants is overwhelming for Roku's smaller-scale business.
- Roku's profit margins may have improved in recent quarters but are still quite slim. In particular, the devices segment weighs on the company's bottom line with a steady stream of negative gross margins -- so it's bound to lose money every time a Roku-branded streaming stick, set-top box, or smart TV makes it from store shelves to living rooms. That's not a sustainable business plan.
- David feels that the Vizio deal highlights how expensive Roku's stock is. Roku's annual revenue stream may be twice as large, but that doesn't mean it deserves more than four times Vizio's market cap. After all, Vizio currently generates a small profit while Roku is losing money.
- Finally, David isn't impressed by the Roku experience. Alternative vendors like Samsung and Amazon offer comparable user experiences, and he may even prefer a Samsung TV's built-in software over adding a Roku stick. So where's Roku's business moat?
Time for a bullish rebuttal
As you might imagine, I don't agree with David's bearish Roku analysis. In fact, I see a couple of these purported problems as actual business advantages.
- Heavy competition is nothing new for Roku. The company has faced behemoths like Amazon, Samsung, and Apple since the very beginning -- and still racks up a 55% market share in recent media-streaming system sales, according to Pixalate. Giving Vizio a Walmart-backed budget may shift the balance a little bit, but the deal doesn't look like a game changer.
- Roku has chosen to run its business with slim profit margins since the inflation-based downturn started in 2021. Rivals protected their margins and contributed to the inflation problem by raising their prices, while Roku largely held its pricing flat, instead. As expected, gentler price tags drove strong unit sales throughout the economic crisis. You can call the devices segment's weak margin a marketing expense, as it helped Roku lift its active user count from 60 million to 80 million in two unprofitable years.
The company actually reported $176 million of free cash flow (FCF) in the most recent quarter, despite $104 million in negative earnings. Vizio's FCF stopped at $12 million in its latest earnings report. Again, Roku can control its profit margins by adjusting device prices. It's simply too early to sacrifice high growth at the altar of richer bottom-line profits. - On that note, I'm not convinced that Vizio's stock is any cheaper than Roku's. Sure, Vizio's stock trades for 1.3 times sales, while Roku's is worth 2.6 times sales, but that's comparing potatoes to oranges. Roku's sales are up 89% over the last three years, while Vizio's dropped 16% lower. If anything, I'm scratching my head over Walmart's willingness to pay $2 billion for that struggling business. Roku has earned its market cap the hard way.
- I can't debunk David's personal experience with Roku's platform and comparable options. Beauty is in the eye of the TV viewer. However, Roku's 55% share of smart media device sales speaks volumes about the platform's combination of a polished user experience, reasonable price, and unbeatable support for different streaming services. Sector rivals may leave streaming platforms from direct competitors unsupported by their future media services, but it doesn't make sense to skip the world's most popular streaming software provider.
ROKU Revenue (TTM) data by YCharts.
Roku is a strong buy
Feel free to do your own research and see where you land on the bull-to-bear scale. Some will side with David's analysis, leaving more bargain-priced Roku shares on the table for the rest of us. Only time will tell who's really right.
Still, I'm happy to bet real money on Roku's long-term future. The markets for smart TV sales and digital advertising will surely rebound as the era of skyrocketing inflation fades into a distant memory. It's a big world out there, and Roku's growth story is just getting started -- and this tasty growth stock looks incredibly cheap.
