The "Magnificent Seven" refers to seven of the largest publicly traded tech companies in the world: Nvidia, Meta Platforms, Apple, Amazon, Microsoft, Alphabet, and Tesla. For what it's worth, this article is predicated on my belief that most of these companies are overvalued right now, and returns for the next three years consequently look modest to me.
Against this backdrop, I believe Roku (ROKU -10.29%) has a much higher chance of skyrocketing over the next three years. Its market-beating potential isn't a guaranteed outcome. But there are several reasons to believe this stock is a coiled spring ready to be released. Here are three of them.
1. Roku stock is cheap
If the "Magnificent Seven" is expensive as a whole, Roku stock is downright cheap. This is the first reason to be optimistic about its potential over the next three years.
Roku stock is down nearly 90% from its all-time high in 2021. Since its high, the company's price-to-sales (P/S) valuation has dropped from almost 30 to where it trades now at a P/S ratio of 2.6.
ROKU PS Ratio data by YCharts
This represents about a 90% drop in the valuation of Roku stock -- in other words, the drop in stock price is 100% valuation related. And this is a good thing for investors who buy shares today. A cheaper stock can be less risky than an expensive one, provided the business creates shareholder value in the future.
Roku can create shareholder value with profitable growth, which brings me to my next reason why this stock can perform well over the next three years.
2. Roku is poised for explosive growth
Many skeptics question Roku's competitive advantage for providing a connected-TV operating system and hardware. And it's a fair question. Some Roku shareholders might point to the neutrality of the platform compared to companies such as Amazon, which provides similar products and services but also has its own streaming service.
To me, this argument for Roku's competitive advantage isn't satisfying. Therefore, it's fair to worry about competition when it comes to Roku.
That said, competition hasn't been a problem so far, and this is an important point. The company ended 2023 with 80 million active accounts, up 14% year over year, making it the largest connected-TV company.
Roku's 80 million active accounts is significant for its growth potential for two reasons. First, it's still attracting new users at a compelling rate, which bodes well for its future revenue potential. Second, there's a strong case that its current accounts are undermonetized.
Roku generates revenue by displaying ads. Active accounts are up, and streaming hours are up, too. But its average revenue per user dropped 4% year over year in the most recent quarter, reflecting a weak advertising market. I'm not sure when it will happen, but I expect a full advertising rebound within the next three years.
Roku's revenue could go up by gaining new accounts and by increased advertising demand, which would lead to higher ad rates. These two sources of top-line growth could consequently lead to explosive revenue growth at some point in the near future.
3. Roku can be profitable
Roku had nearly an $800 million operating loss in 2023 -- when discussing shareholder-value creation, this is a problem. That said, the company has demonstrated profitability in the past, so it's possible. And the profit margin was actually quite good for a brief time.
ROKU Revenue (TTM) data by YCharts
According to management, Roku's current losses are intentional -- it's aggressively lowered its hardware prices and is spending money to gain market share. One might disagree with the premise or the approach. But if true, this suggests that the company's losses are temporary and at some point, profits will improve.
When it comes to Roku stock skyrocketing over the next three years, I feel very comfortable making two statements: The stock is cheap now, and its revenue will likely soar in coming years. That forms the basis for my conviction that it could outperform the Magnificent Seven.
The third issue regarding Roku's profits is more of a wild card, but nonetheless important. Part of the reason the stock is cheap is the market doesn't believe the company has what it takes to sustainably generate positive cash flow. If Roku bucks the bearish narrative and turns the corner on profits, expect the market to finally give it more credit.
On the other hand, if in three years Roku is still racking up losses like it is today, I'd expect Roku stock to be a market laggard. The company can't operate indefinitely with losses this large.
Personally, I believe Roku has what it takes and believe its prospects will get better with scale. But it does still have a lot to prove.
