Roku (ROKU -10.29%) was a darling of the pandemic. Locked-down consumers turned to the platform amid restrictions on outside activities, and consequently, investors bid the stock to a high of more than $490 per share in the summer of 2021.
However, investors sold Roku as lockdowns ended, and ongoing losses left the company's stock unable to gain traction. As a result, it sells at a discount of more than 85% from that high.
Nonetheless, Roku remains the leading television operating system in key markets, and it continues to grow its user base at a rapid clip. The question for investors is whether that will help it outperform the "Magnificent Seven" over the next five years.
Roku and the Magnificent Seven
At first glance, investors may laugh off the prospect of Roku being a top stock. Unlike the Magnificent Seven stocks, Roku is far off its highs and has failed to grow average revenue per user (ARPU), which is a key metric. In the fourth quarter of 2023, ARPU came in at $39.92, down from $41.68 in the year-ago quarter.
On the Q4 2023 earnings call, the company cited a focus on international markets as the cause of the drop, as it seeks to increase engagement and scale in such places. Nonetheless, it also attributed its performance to an "uneven" recovery in the ad market. This may frustrate investors who believe that Roku should grow faster as ad dollars move from traditional TV to streaming.
Another frustration is the company's net income. In 2022, Roku turned profitable amid the temporary bump in viewership resulting from the lockdowns. Still, Roku resumed its losses as consumers returned to pre-pandemic activities.
Also, on the earnings call, CEO Anthony Wood repeatedly cited the company's "positive adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization)." While that may sound positive, such language often indicates an inability to achieve a positive generally accepted accounting principles (GAAP) net income, a challenge the Magnificent Seven stocks do not face.
Why it might be too early to count Roku out
However, for all its problems, investors have many reasons to not give up on Roku. As mentioned, it is the leading television OS, particularly because it is the No. 1-selling TV OS in the U.S., Canada, and Mexico. This is notable as it faces competition from cash-rich Magnificent Seven stocks such as Amazon, Alphabet, and Apple, as well as tech giant Samsung.
Also, despite the drop in ARPU, Roku's platform continues to gain popularity. Its user base grew 14% in 2023 to 80 million, while users streamed 21% more content over the same period. This bodes well for the company as it seeks to grow its market share in Latin America and Western Europe. Such improvements should turn to revenue gains as the ad market improves.
Another factor that could draw investors is valuation. Roku's price-to-sales (P/S) ratio once exceeded 30 at the height of the pandemic, but amid its declines, its P/S ratio is now less than 3. This has occurred at a time when its user base has continued to grow.
Additionally, it trades at a lower sales multiple than all the Magnificent Seven stocks. This includes Amazon, whose P/S ratio is skewed lower by low-margin retail sales, and Alphabet, which has struggled amid heavier artificial intelligence (AI)-related competition from its rivals. That factor could bode well for Roku if it can achieve higher growth levels.
ROKU PS Ratio data by YCharts
Will Roku outperform the Magnificent Seven in five years?
Given what investors know today, they should not assume Roku will outperform the Magnificent Seven over the next five years.
Indeed, much can happen in a five-year time span, and Roku showed how its platform can grow during the pandemic. The steady increase in customer numbers and streaming hours could bring considerable revenue increases in a more robust ad market.
Nonetheless, Roku is unlikely to perform at a high level as long as ARPU continues to shrink. Moreover, it shows no sign of returning to positive GAAP net income anytime soon. Therefore, until investors see a significant improvement in revenue growth, this entertainment stock is unlikely to outperform today's top tech stocks.
