Roku (ROKU -1.10%) hasn't been the best to its investors in the past three years as its shares are down an eye-watering 83%. The Nasdaq Composite index has produced a total return of 25%, which makes Roku's performance even more disappointing.
This beaten-down streaming stock could make for a smart investment right now. Where will Roku be in three years?
Powerful tailwinds
Despite Roku shares being 88% off their all-time high, the business has continued to grow at a nice pace. Revenue in Q1 2024 (ended March 31) was up 19% year over year and 54% higher than in the first quarter of 2021. The growth has slowed amid macro and industry headwinds, but it's still healthy.
If we look out to 2027, I think it's safe to assume that Roku will be generating higher sales at that time. The company benefits from the ongoing cord-cutting trend of households ditching their cable subscriptions in favor of streaming entertainment. Even in the U.S., there's a sizable runway.
Roku is the leading smart TV operating system in North America, with 81.6 million active accounts that streamed 30.8 billion hours of content in the last quarter. The virtually unlimited number of streaming choices on the market makes Roku's platform attractive to viewers who want everything in one place.
The company also is benefiting from the rise of digital advertising. While this industry has proven to be more cyclical than investors had hoped, its long-term prospects are favorable. With more TV viewing time shifting to streaming, the ad dollars should naturally follow. This puts Roku in an advantageous position.
Waiting for profitability
Throughout its history, Roku hasn't been consistently profitable. It's not a surprise that management has been focused primarily on growing at all costs, mainly because they see a huge opportunity in the industry.
However, given the current state of the economy -- one characterized by higher interest rates and inflationary pressures -- I'm not sure that investors will give businesses the leeway they did when monetary conditions were looser a few years ago. In Roku's case, this means it needs to start producing positive earnings sooner rather than later.
The company was able to post positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) and free cash flow in three straight quarters, a streak that's still active. And its operating loss continues to shrink.
These are positive trends. Hopefully management isn't sacrificing growth in the name of driving greater operational efficiencies.
With what should be a higher revenue base three years from now, Roku will be able to better leverage what are mainly fixed costs, like product development, marketing, and corporate overhead. Therefore, I would expect the business to eventually get to GAAP profitability.
Valuation expansion
In 2027, it's not a stretch to believe that Roku will be a bigger business with an improved financial profile. Stronger fundamentals should bode well for the stock price.
Expectations are low right now, as investors seem to be pessimistic about the state of the business. Shares trade at a price-to-sales (P/S) ratio of 2.3 today, which is well below their historical average of 9.8.
I'm confident that the P/S multiple will rerate higher as the business stabilizes and positive earnings become a normal occurrence. Assuming the shares get to a P/S ratio of 4, which I think is reasonable, it adds 74% to the upside just from a valuation perspective.
Add in improving investor sentiment to a company that's set to be larger three years from now, and investors should consider buying the stock today.
