General market uncertainty, combined with slowing revenue growth, has punished shares.
The past few months have not been friendly to high-multiple, high-growth tech stocks. Soaring inflation has pushed the Fed to plan to raise interest rates this year, sparking a sell-off into safer assets. Add in the recent geopolitical turmoil, and we have the ingredients for major uncertainty in the stock market.
Streaming platform Roku ( ROKU -6.31% ) has been severely affected, and its stock has been in a downward spiral since last July. Roku’s share price has fallen roughly 50% so far in 2022, as overall market pessimism continues hammering the stock. The company is also facing its own set of problems, giving investors lots to think about.
Roku is dealing with inflation
Like the rest of the economy, Roku is facing inflationary pressures and supply-chain issues relating to the company’s sale of media sticks. While hardware sales only represented 17% of the business in 2021, over the past three quarters, Roku has posted a widening loss — a negative 28.4% in the most recent quarter on a gross margin basis. Management has decided not to pass on higher component costs to customers.
Roku’s licensed TV partners are also trying to navigate the situation. “Similar to Q3, overall U.S. TV unit sales in Q4 fell below pre-COVID 2019 levels,” Anthony Wood, Roku’s founder and CEO, highlighted in the shareholder letter. These inventory challenges are clearly hurting sales figures. Since Roku’s main objective is to get its operating system into as many households as possible, any headwind to achieving this certainly hurts company performance.
In 2021, 83% of Roku’s overall sales came from its platform segment, which includes high-margin advertising and subscription fees. This is the bread and butter of the business, but even it is struggling in the current economic environment. Organizations that advertise on Roku’s platform, particularly in industries like autos and consumer packaged goods, pared back ad spend in the fourth quarter due to their own supply chain disruptions.
Although Roku increased revenue 33% in Q4 2021, the growth rate missed Wall Street expectations. Furthermore, first-quarter 2022 guidance of 25% year-over-year sales growth disappointed as well. Higher component costs and ongoing supply-chain challenges will continue to negatively affect Roku in the near term, so investors shouldn’t be surprised if the player segment’s gross margin remains negative in the next few quarters.
On a positive note, I believe that these issues will prove to be temporary. And the market’s pessimism on Roku provides a great buying opportunity for investors.
The future still looks promising
If we zoom out and focus on the bigger picture, we’ll see that Roku is in a prime position to benefit from the world’s transition away from traditional cable TV and toward streaming entertainment.
Roku is the top streaming platform in the U.S., Canada, and Mexico by hours streamed. In 2021, Roku’s 60.1 million active accounts (up 17% year over year) viewed 19.5 billion hours (up 15% year over year) of content. And monetization continues showing strength. Average revenue per user of $41.03 over the trailing 12 months was up 43% compared to the prior-year period.
There are 1 billion cable-TV subscriptions worldwide, signaling a massive opportunity ahead for Roku. On a micro level, Roku’s management cites Nielsen data that shows that the average household in the U.S. watches eight hours of TV per day. And Roku’s average active account streams 3.6 hours per day, leaving room for engagement to grow in order to control more TV time.
And as more TV time goes to streaming, advertising dollars will ultimately follow. According to eMarketer, connected-TV ad spending in the U.S. is forecast to exceed $30 billion in 2025, increasing its share of total digital ad spending. Roku is in an extremely advantageous position to capitalize on this trend.
Valuation is at a three-year low
Roku’s stock is now trading for 5.7 times 2021 revenue. This is the lowest multiple shares have sold for in about three years. The market has completely thrown out Roku with other tech stocks. But this business is a huge leader in the streaming space, and it also has the chance to capture a big chunk of ad dollars that will inevitably flow to connected TV over the next decade.
With a more attractive valuation today, and a long-term thesis that remains intact, Roku’s stock looks like a screaming buy right now.
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